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THE BANKING & CURRENCY 

PROBLEM 
IN THE UNITED STATES 



BY 

VICTOR MORAWETZ 




^'JJJ^J ' ' ' .■'■■'■■'-A.12 



NORTH AMERICAN REVIEW PUBLISHING CO. 
Franklin Square, New York, N. Y. 

MCMIX 






*RY of CONGRESS 

Two Cooies Received 

JAN 20 1909 

Copyright Entry 

0LASS <=*- XXc, No, 

;CPY B. 



Copyright, 1909, by 
The North American Review Publishing Co. 



All rights reserved. 
Published January, 1909. 



CONTENTS 

PAGE 

The Problem i 

Causes of "Money Stringency" 7 

The Creation of Bank Credits 12 

Bank Reserves and their Character 15 

Bank Reserves and Liabilities in the United States 20 

Increase of Reserve Money 22 

Maintenance of the Gold Standard and of Cash 

Payments 25 

Issue of Bank-Notes 27 

Effects of Issuing Bank-Notes 28 

Difference between Notes and Other Instruments 32 

Regulation of the Banks 34 

Insufficient Reserves and Over -Expansion of 

Credits 36 

Minimum Reserves of National Banks 38 

Over-Expansion with Regard to the General Credit 

Situation 43 

Central Regulation Necessary 45 

The Central Bank Plan^ 50 

Central Bank Not Practicable in the United States 52 

Independent Bank-Note Issues 55 

The Currency Situation in the United States . . 58 



CONTENTS 



PAGE 



Regulation by Taxation 62 

Regulation by Government Note Issue .... 66 

The European System of Commercial Credits . . 69 

Guarantee of Bank Deposits 72 

State Banks and Trust Companies 79 

How Central Regulation can be Secured ... 84 

Plan for Central Regulation in the United States 87 

Branches and Agencies 89 

Meetings of the Board of Managers, etc. . . 90 

Limit of Note Issues under Plan 90 

Redemption Fund under the Plan 91 

Separate Reserves for the Notes 94 

Operation of the Plan Illustrated 97 

Uniform or Separate Note Issues of the Banks 102 

Security of the Notes 107 

Collateral Security no 

Protection of United States Bond Values . . 114 

Taxation of Notes Under the Plan 114 

Existing Bond-Secured Notes 117 



THE BANKING AND CURRENCY 

PROBLEM 

IN THE UNITED STATES 



THE 
BANKING AND CURRENCY 

PROBLEM 
IN THE UNITED STATES 

THE PROBLEM 

For many years the country has suffered from 
recurring periods of severe financial stringency. 
During these periods interest rates have been ex- 
cessively high, and business men have lost heavily 
through inability to obtain necessary loans and 
discounts from the banks. At times wide-spread 
panic and general suspension of payments by 
the banks have resulted from runs upon a few 
banks by their depositors. Only recently we have 
emerged from a disastrous panic which forced the 
suspension of nearly all the banks, and, by the 
destruction of confidence and credit, arrested busi- 
ness activity throughout the country and caused 
vast losses to the people. This panic brought to a 



THE BANKING AND CURRENCY PROBLEM 

violent close a period of unprecedented prosperity, 
in which manufacturers and merchants had not 
unduly expanded their obligations for the purpose 
of carrying unsold stocks of goods. On the con- 
trary, production had been barely able to keep 
pace with demand for the products of industry. 

Such extraordinary financial disturbances do 
not occur in other civilized countries. They in- 
dicate that something is seriously wrong with the 
system of banking and currency in the United 
States. The National Monetary Commission was 
created for the purpose of devising a remedy that 
will prevent similar disturbances in the future. 

When a doctor is called in to prescribe for a 
patient, his first step must be to discover the 
disease that causes the symptoms of which the 
patient complains. Similarly, before the Com- 
mission can intelligently prescribe remedies it must 
ascertain what is wrong with our present financial 
system. The first step must be to discover the true 
cause of our financial troubles. The next step 
should be to devise a remedy that will remove the 
existing cause of trouble, but will not itself intro- 
duce a new source of trouble or of danger. 

Occasional bank failures and runs upon isolated 
banks by panic-stricken depositors do not prove 
that anything is wrong with our system of banking 
and currency. A bank may become insolvent and 



IN THE UNITED STATES 

may fail in consequence of dishonesty or incom- 
petence of its officers ; and the depositors of a bank 
may become panic-stricken in consequence of some 
false report, though there be nothing wrong with 
their bank. No system and no legislation can 
make bank managers honest and prudent, or guard 
against the penalties of dishonesty and imprudence, 
and no system can enable a bank to keep in its 
vaults enough cash to pay off all its depositors at 
once if they make a run upon the bank. But if 
the failure of one bank or of several banks, or a 
panic among their depositors, results in the sus- 
pension of practically all the banks, as happened 
recently, something must be radically wrong with 
the whole system, or in the method of conducting 
the banking business in the United States. A 
system of banking that fails to make adequate pro- 
vision against unexpected contingencies, such as 
the suspension of one bank or of several banks — a 
system that works satisfactorily only in financial 
fair weather — clearly is unsound and inadequate. 
Such a system is as unsafe as a ship that can sail 
only in fair weather and is likely to founder during 
the first storm. We have in the United States a 
banking system that in normal times has served us 
well — a satisfactory system of fair-weather bank- 
ing. What we need is a system that will carry us 
safely through periods of financial stress and storm. 

3 



THE BANKING AND CURRENCY PROBLEM 

The immediate cause of a stringency in the 
money-market, of excessive interest rates, of in- 
ability of the banks to grant the credits needed for 
the transaction of the legitimate business of the 
country, or of a general suspension of cash pay- 
ments by the banks, is that the banks either have 
expanded their deposit liabilities or have reduced 
their reserves beyond the limit of safety. It is 
obvious that if the banks keep their reserves of 
cash large enough in relation to their deposit lia- 
bilities, or (putting it the other way) if they keep 
their deposit liabilities small enough in relation to 
their cash reserves, so that at all times they will 
be able to pay cash to depositors who demand cash, 
the banking situation as a whole will be safe. 

But to keep the banks in a safe condition, and 
to prevent bank failures and panics, is only part of 
the problem. It is necessary, also, to devise a 
system of banking that will meet the require- 
ments of trade and commerce. The business of 
the world is based on credit, and the banks are 
the instruments by which this credit is created. 
Modern enterprise and business activity would be 
utterly impossible without an enormous volume 
of bank credits. The aggregate deposit liabilities 
of the National banks alone amount to more than 
$5,000,000,000, and their loans and discounts 
amount to about that sum, while the aggregate 

4 



IN THE UNITED STATES 

individual deposit liabilities of all the banks and 
trust companies in the United States, including 
the National banks, amount to more than $13,- 
000,000,000, and their loans and discounts to more 
than $10,500,000,000. These enormous volumes of 
bank credits cannot be diminished without dimin- 
ishing the business prosperity of the country ; and 
unless the volume of bank credits can keep on ex- 
panding still further there must be a check to the 
future development of the country and to its busi- 
ness prosperity. 

Our banking troubles cannot be prevented by 
the simple means of compelling the banks to keep 
larger minimum reserves or by restricting their 
power to grant credits. All possibility of bank 
failures could be prevented by abolishing the banks 
altogether, but that would be killing the patient 
in order to destroy the disease. The risk of bank 
failures and of panics might be reduced to a mini- 
mum by requiring the banks to keep on hand very 
much larger reserves of money than now in pro- 
portion to their deposit liabilities, but this would 
merely compel the banks to reduce their loans and 
their deposit liabilities so as to bring about the 
required relation between the reserves and the de- 
posit liabilities. From self-interest the banks make 
their reserves as large as possible, because the 
amount of their reserves determines the amount of 

5 



THE BANKING AND CURRENCY PROBLEM 

credits they can grant and consequently the amount 
of money they can earn by making loans and dis- 
counts. A law requiring the banks to keep larger 
reserves in proportion to their deposit liabilities 
would not enable them to increase their reserves 
by a dollar; it would merely contract their power 
to grant credits, and this contraction of the power 
to grant credits would create a financial stringency 
and raise interest rates. If carried too far, it 
would arrest business and destroy enterprise. 
Safety of the banking situation undoubtedly must 
be secured, but it is no less important to provide 
for the largest volume of bank credits consistent 
with safety, so that business prosperity may not 
suffer. The problem, therefore, is not merely to 
make banking safe and to prevent future panics; 
the problem is to devise a system that will permit 
of the largest possible expansion of bank credits 
consistent with safety. 

No system of banking and currency can be sound 
or prove of lasting value unless it shall accord with 
the elementary principles of economic science ap- 
proved by the leading financial experts of the 
world. Failure to realize the full force and effect 
of these established elementary principles, and to 
apply these principles correctly and consistently, 
has been the source of many popular fallacies that 
have prevailed in the United States. It is desir- 

6 



IN THE UNITED STATES 

able, therefore, in discussing the banking and 
currency problem, to state and to explain briefly 
some of these elementary principles, although 
they may be familiar to students of economic 
science. 



Causes of " Money Stringency " 

The entire currency of the country consists of 
approximately three thousand million dollars. Of 
this sum less than three-fifths is ever in actual cir- 
culation among the people. A little more than 
one-third, or approximately twelve hundred million 
dollars, is held by the banks and trust companies 
as a reserve for the payment of their depositors on 
demand, and more than two hundred million dol- 
lars are held by the Government. The aggregate 
amount of currency actually used by the people of 
the United States as a circulating medium — that 
is to say, the aggregate amount carried in their 
pockets, or kept in cash-drawers or in safes for use 
in business, or hoarded in secret places — fluctuates 
from time to time. The amount thus used as a 
circulating medium by the people at any one time 
depends wholly upon the will of the people and 
upon their need of a circulating medium. No cur- 
rency plan would in the least increase or diminish 
the amount of currency actually used by the peo- 

7 



THE BANKING AND CURRENCY PROBLEM 

pie as a circulating medium. Any one who has a 
bank-account, or who has property for sale, or 
who has credit enabling him to borrow, always can 
obtain currency from the banks, unless they break 
their contracts with depositors and violate their 
legal duty by refusing on demand to pay in cur- 
rency checks of their depositors. Though the cur- 
rency of the country were doubled in volume, this 
would not put a dollar into the pockets of any man, 
except as received by him in payment for labor or 
property, or as a gift, and the amount of currency 
actually in circulation would not be increased by a 
dollar. People would not carry in their pockets 
more currency than at present. On the other 
hand, whenever the currency in circulation exceeds 
the amount which the people want to carry in their 
pockets, or to keep in their tills and in cash-boxes, 
or to hoard, this excess will be deposited in the 
banks and trust companies. The reserves of the 
banks and trust companies are merely the surplus 
of currency left over after supplying these wants 
of the people for currency as a circulating medium. 
Therefore, it follows that as the amount of currency 
used for actual circulation fluctuates, so also the 
bank reserves will fluctuate, except so far as these 
fluctuations may be compensated by the importa- 
tion of gold, or by the issue of bank-notes, as 
hereafter will be pointed out. 

8 



IN THE UNITED STATES 

Various causes produce these fluctuations in the 
amount of currency used as a circulating medium. 
When business is active and labor throughout the 
country finds profitable employment, more money 
is kept in circulation to pay wages and to make 
other cash payments, and people carry more pocket- 
money than in dull times. Usually about Christ- 
mas-time there is a special demand for currency on 
account of the requirements of holiday trade. But 
the largest fluctuation is caused annually by the 
requirements of the West and South for cash to 
make payments incidental to harvesting and to 
moving the crops. It is difficult to determine ac- 
curately the extra amount of cash needed for this 
purpose, but it is estimated that to move the crops 
there is required, annually, aproximately two hun- 
dred million dollars, or about 7 per cent, of the 
entire currency. After a few months the extra 
amount of currency, being no longer needed to 
move the crops, is returned to the banks and trust 
companies and again becomes part of their reserves. 

As the whole amount of currency used as a cir- 
culating medium by the people never exceeds three- 
fifths of the entire currency in the country, it is 
obvious that the currency is ample for the uses of 
the people as a circulating medium. When it is 
said that money is tight, or that a stringency exists 
in the money-market, this does not mean that there 



THE BANKING AND CURRENCY PROBLEM 

is insufficient currency in the country to meet the 
needs of the people for a circulating medium. It 
means, really, that people cannot obtain loans and 
discounts from the banks, because the banks are 
unable to grant further credits, their reserves of law- 
ful money being insufficient. It means either that 
the banks and trust companies have expanded their 
deposit liabilities in relation to their reserves to the 
limit of safety, or to the legal limit, and that they 
cannot lend their credit any further by the creation 
of deposit liabilities, or else that they feel com- 
pelled to call in loans so as to increase their reserves 
or to reduce their deposit liabilities. It does not 
mean that the people cannot have all the currency 
they want for circulation, unless, as recently, the 
banks actually suspend cash payments. Even 
when the banks suspend cash payments, and there 
appears to be a currency famine, as in the recent 
panic, the real cause of the trouble, and the source 
of danger, is not the inability of depositors to obtain 
currency from the banks. This inability to obtain 
currency was an inconvenience, but not very serious, 
because, generally, debts could be paid by check. 
The seriousness of the panic arose from the fact that 
the banks, having expanded their deposit liabilities 
in relation to reserves beyond the limit of safety, 
were compelled to call in loans that could not be 
paid immediately without enormous sacrifices, and 

IO 



IN THE UNITED STATES 

were compelled to refuse to make loans and to grant 
credits for legitimate and necessary business pur- 
poses. 

Tight money, or a stringency of the money- 
market, whether general or sectional, may result 
from one or more of the following causes — viz., 
(i) the banks may be unable to grant further 
credits, or they may be compelled to reduce the 
amount of their credits, because their reserves have 
been reduced by unusual withdrawals of lawful 
money, as may happen when a large amount of 
money is used to pay duties and other taxes and is 
locked up by the Government, or when a large 
amount of currency is withdrawn either for use as a 
circulating medium in the West and South to "move 
the crops/ ' or to be hoarded by panic-stricken de- 
positors, or when a large amount of gold is drawn 
for export; or (2) the banks may be unable to grant 
additional credits, because through extraordinary 
activity in business the aggregate amount of credit 
desired has been increased to the limit permitted 
by their reserves of lawful money; or (3) the persons 
who desire credit may be unable to furnish satis- 
factory assurance or security to such banks as may 
be able still to grant credits. 

It is obvious, then, that our currency question 
is really a question of bank credits and bank re- 
serves, The problem is, while preventing any un- 

11 



THE BANKING AND CURRENCY PROBLEM 

safe expansion of credits or the issue of any unsafe 
currency, to find a way, (i) to avoid a depletion of 
bank reserves and the consequent large reduction 
of bank credits in times when lawful money is with- 
drawn to pay taxes and is locked up by the Govern- 
ment, or when lawful money is largely withdrawn 
for use as a circulating medium to move the crops, 
or to be hoarded; and (2) to enable the banks, in 
times of great business activity, to expand their 
deposit liabilities and their loans and discounts, 
and also adequately to increase their reserves of 
lawful money. 



The Creation of Bank Credits 

The National banks owe to their depositors in the 
aggregate six or seven times the aggregate amount 
of currency held by these banks. The banks and 
trust companies of the United States, including the 
National banks, collectively owe to their individual 
depositors (not including deposits of one trust com- 
pany or bank in another trust company or bank) 
more than thirteen thousand million dollars, pay- 
able on demand, this sum being about twelve times 
the aggregate amount of currency held by all the 
banks and trust companies, or more than four times 
the entire currency of the United States. 

In dealing with the banking and currency prob- 

12 



IN THE UNITED STATES 

lem, it is of paramount importance to bear in 
mind that, in large part, these so-called deposits 
in the banks and trust companies are created with- 
out the actual deposit of any money. The ex- 
pression "bank deposits" often is misleading to 
those who are not familiar with the actual course 
of banking operations. In very large part the de- 
posit liabilities of the banks and trust companies 
are created by mere book entries representing loans 
of the credit of the banks for a consideration re- 
ceived by them in the form of interest. 

As a rule, when a borrower applies to a bank for 
a loan he does not want to carry away the amount 
of the loan in currency. What he wants is a credit 
so that from time to time in the course of his busi- 
ness he can draw his checks upon the bank. Ac- 
cordingly, the bank discounts the borrower's note, 
and credits his deposit account with the amount 
of the note, less the interest, as though he had 
actually deposited that sum, although in fact he 
never deposited a dollar in money. The borrower 
receives from the bank only a deposit credit, and 
usually there is a tacit or expressed understanding 
that he will not draw 7 against this credit except 
from time to time, in the course of his business, 
and that as long as he continues to be a customer 
of the bank he will allow a reasonable balance to 
remain undrawn. The bank receives no money, 

13 



THE BANKING AND CURRENCY PROBLEM 

but by means of a book entry its nominal deposits 
are increased by the amount of the loan, less the 
interest, which, commonly, is deducted in advance. 
The real transaction is simply an exchange of credits 
between the bank and the borrower. If, however, 
the transaction should take the form of an actual 
payment of money to the borrower, this money 
soon would be deposited again in the banks, either 
by the borrower or by other persons receiving it in 
the course of business, and thereupon from time to 
time the same money could be loaned out again and 
be redeposited. The deposit liabilities of the banks 
would be increased on each occasion when the 
money, after having been paid out by the banks by 
way of a loan, is returned to them as a deposit. 

By these processes the deposit liabilities of the 
banks may be increased almost indefinitely without 
increasing the amount of money held by them. The 
only absolute limitation is that imposed by the 
necessity of holding as a reserve an amount of money 
sufficient to supply depositors with the sums they 
are likely to withdraw for use as currency, and to 
enable the banks to settle with one another such 
balances as cannot be settled by exchanges of 
checks through the clearing-houses. In large part 
the business of banking consists of making loans 
and of discounting notes payable with interest at 
future dates in consideration of the assumption of 

14 



IN THE UNITED STATES 

deposit liabilities payable on demand, without in- 
terest or at a low rate of interest, it being understood 
that a large part of these deposit liabilities always 
will be allowed to remain unpaid. 

The business of the country cannot be carried 
on without the use of a stupendous amount of credit. 
Bank credit serves this purpose where the credit 
of individuals would not be acceptable. The great 
service rendered by the banks is that they furnish 
in acceptable form the vast amount of credit which 
is essential to carry on the business of the country. 



Bank Reserves and their Character 

While a very large part of the aggregate deposit 
liabilities of the banks always is allowed to remain 
unpaid, and while the great bulk of the transactions 
of the banks can be effected by set-off through the 
clearing-houses without the actual delivery of cur- 
rency, yet prudence requires every bank and every 
financial institution to keep on hand sufficient cur- 
rency to enable it to meet all demands for currency 
that are likely to be made upon it, having regard 
to all the prevailing conditions. In England the 
amount of currency that the banks must reserve in 
their vaults to meet their deposit liabilities is not 
fixed by statute, but is left to the judgment of the 
banks. In the United States the laws require the 

15 



THE BANKING AND CURRENCY PROBLEM 

National banks and the various State banks and 
trust companies to keep on hand certain minimum 
reserves proportionate to their deposit liabilities. 
The requirements of the laws as to minimum re- 
serves vary widely with respect to the different 
classes of banks and trust companies, and each 
State has prescribed its own rules. 

The character and sufficiency of bank reserves 
must be considered with regard to the banking 
situation as a whole as well as with regard to the 
affairs of each separate bank. 

Thus, a deposit claim of one bank against an- 
other bank — that is to say, its right to call upon 
such other bank for the payment on demand of a 
sum of money — may be treated as a reserve, if we 
leave out of consideration the position of the banks 
collectively and the general banking situation. 
But, obviously, the liability of a bank to pay money 
to another bank would not increase the collective 
ability of all the banks to pay all their depositors 
and would not in the least strengthen the gen- 
eral financial situation. When a particular bank 
strengthens its own reserve by drawing upon its 
deposit with another bank, it weakens to the same 
extent the reserve of the bank upon which it draws. 
Therefore, when there is a general money stringency 
— that is to say, when the banks throughout the 
country have expanded their credits to the limit 

16 



IN THE UNITED STATES 

of safety — the deposits of certain banks in other 
banks are not good as reserves, and do not in the 
least strengthen the general banking situation. 
We had an illustration of this during the recent 
panic, when the credit situation had become strain- 
ed throughout the entire country. The Western 
banks having large deposits with the New York 
banks began to draw against them, thereby 
diminishing the reserves of the New York banks; 
but as the latter, quite as much as the Western 
banks, needed their reserves, the money stringency 
in New York soon reached the breaking-point, and 
all the New York banks suspended cash payments. 
Under these circumstances the deposits of the 
Western banks were of no use to them as reserves. 
Similarly, bank-notes may be treated as a reserve, 
if the position of the bank holding such notes be 
considered without regard to the general banking 
situation ; but, having regard to the situation of all 
the banks, it is clear that such notes are not good 
as a reserve. A bank-note is merely a promissory 
note payable in money on demand. Bank "A" 
holding notes of bank "B " may consider such notes 
as good as money so long as bank "B" is solvent 
and pays its obligations on demand; but it is 
obvious that when bank "A" obtains money from 
bank "B" by requiring it to redeem its notes the 
reserves of bank "B" will be diminished exactly as 

17 



THE BANKING AND CURRENCY PROBLEM 

much as the reserves of bank "A" are increased. 
That, having regard to the entire banking situa- 
tion, bank-notes are not a good reserve becomes 
apparent upon considering the case of several 
banks exchanging their notes, and each bank call- 
ing upon the others to pay their notes in lawful 
money. 

As long as financial conditions are normal, call 
loans may be regarded as a good reserve, because 
a bank can obtain cash promptly by calling such 
loans; but call loans do not strengthen the general 
banking situation, and, therefore, when there is a 
severe money stringency, they are not good as a 
reserve. When a bank calls a loan, the borrower 
either must borrow the same sum from some other 
bank, although required to pay a very high rate of 
interest, or he must obtain the required sum by 
selling property, and in that event the purchaser 
usually must draw the money from the banks. 
Therefore, when a bank strengthens its reserve by 
calling a loan, the practical effect is to draw the 
money from other banks and pro tanto to weaken 
their reserves. 

For similar reasons, as long as financial condi- 
tions generally are not strained, bonds or other 
securities that have a ready market may serve as a 
reserve, because by selling such bonds or securities 
a bank can obtain money; but reserves of that 



IN THE UNITED STATES 

character do not strengthen the general credit 
situation and are not available when most needed 
by the banks that hold them. When a bank sells 
securities in order to obtain lawful money to pay 
its depositors, the purchaser usually must draw the 
purchase price from the banks. The selling bank 
thus would obtain lawful money by drawing in- 
directly from the reserves of other banks. There- 
fore, when there is a general money stringency, 
bonds or other salable securities are not good re- 
serves. During the recent panic many of the banks 
and trust companies, including some of those which 
failed, owned large amounts of high-class securi- 
ties, but this did not help them or relieve the 
general situation, as the combined lawful money 
reserves of the banks and trust companies were 
inadequate. 

Deposits by banks in other banks, bank-notes, 
call loans, and bonds or other securities are not, 
properly speaking, bank reserves at all. They are 
only the means of obtaining reserve money for 
particular banks by drawing this money from the 
reserves of other banks. In considering the general 
financial situation, deposits of banks, bank-notes, 
call loans, and securities held by the banks should 
be disregarded. For the ultimate payment of 
bank-deposit liabilities the only true reserve is 
legal-tender money. 

19 



THE BANKING AND CURRENCY PROBLEM 

Bank Reserves and Liabilities in the United States 

At all times the demand liabilities of the banks 
in the United States are very largely expanded in 
relation to the reserves of money held by them for 
the payment of these liabilities. 

According to the reports of the Comptroller of 
the Currency, on August 22, 1907, and on November 
27, 1908, the demand liabilities of the National 
banks alone were approximately as follows, omit- 
ting all liabilities of National banks to other Na- 
tional banks: 

August 22, 1907. November 27, 1908. 

6,544 Banks. 6,865 Banks. 

Individual deposits $4,319,035,402 $4,720,284,640 

Due to State banks and bank- 
ers, trust companies and 
savings-banks (net amount) 610,652,912 812,351,826 

U. S. deposits (net amount) . . . 156,306,310 118,348,294 

National bank - notes (net 

amount) 520,709,334 561,414,595 

Total $5,606,703,958 $6,212,399,355 

At the same dates the aggregate amount of money 
held by the banks was as follows: 

August 22, 1907. November 27, 1908. 

Specie $531,107,750 $656,528,775 

Legal-tender notes 170,515,782 188,230,744 

In 5-per-cent note redemption 

fund 27,305,679 29,809,485 

Total reserve $728,929,211 $874,569,004 

20 



IN THE UNITED STATES 

The aggregate collective money reserves of all the 
National banks on August 22, 1907, amounted to 
about 13 per cent., and on November 27, 1908, 
to about 14 per cent, of their collective liabilities 
payable on demand, not including liabilities to 
National banks. The aggregate amount of gold 
and gold certificates included in these reserves on 
August 22, 1907, was $404,799,628, or about 7 per 
cent., and on November 27, 1908, was $512,207,371, 
or a little over 8 per cent, of their demand liabil- 
ities to others than National banks. 

According to the report of the Comptroller for 
1907, the collective individual deposits of all the 
19,746 reporting banks and trust companies in the 
United States, including the National banks, on 
or about June 30, 1907, amounted to $13,099,600,- 
000, while their aggregate reserves of cash of all kinds, 
including bank-notes, amounted to $1,113,742,316. 

Thus the collective cash reserves of all of the 
reporting banks and trust companies amounted to 
about 8.5 per cent, of their collective deposit lia- 
bilities to individuals. On or about June 30, 1907, 
the aggregate amount of gold and gold certificates 
held by all these banks and trust companies was 
only $570,692,702, or about 4.4 per cent, of their 
aggregate deposit liabilities to individuals. 

There are no reports from other countries fur- 
nishing definite information as to the aggregate 

21 



THE BANKING AND CURRENCY PROBLEM 

deposit liabilities and aggregate reserves of their 
banks, omitting from the liabilities, as well as from 
the reserves deposits of one bank in another bank 
and bank-notes held by the banks ; but it has been 
estimated that the aggregate amount of gold held 
by all the English banks is about 6 per cent, of 
their aggregate deposits, not counting deposits of 
one bank in another bank or bank-notes held by 
the banks. 

The Bank of England, alone, generally holds a 
reserve of about 50 per cent, of its deposit liabilities, 
and a larger separate reserve for its notes; the 
Bank of France, a reserve of about 80 per cent, of 
its deposit liabilities and notes; and the Imperial 
Bank of Germany, a reserve of about 40 per cent, 
of its deposit liabilities and notes. 



Increase of Reserve Money 

As bank reserves are held for the payment of 
the deposit liabilities of the banks, they should con- 
sist of legal-tender money, or of such other currency 
as the banks can require their depositors to accept. 
Similarly, in the absence of some stipulation to the 
contrary, it should be implied that banks may pay 
their depositors in any kind of currency which, by 
statute, is declared to be good as a reserve against 
deposit liabilities. 

22 



IN THE UNITED STATES 

By statute, gold coin and gold certificates of de- 
posit, silver coin and silver certificates of deposit, 
and Government notes, are declared to be good as 
reserves of the National banks. Gold coin, silver 
coin, and Government notes are made a legal ten- 
der for the payment of debts. The gold certificates 
and silver certificates are not made a legal tender, 
but they can be issued only against a like amount 
of gold and silver deposited with the Government, 
and are convertible on demand into gold coin or 
silver coin. Therefore, there is no good reason 
why such certificates should not be used as bank 
reserves in place of the coin itself, which is legal- 
tender money. 

Though the Government notes are merely promis- 
sory notes of the Government, and though the 
bullion value of each silver dollar coined by the 
Government is only about fifty cents in gold, both 
the Government notes and the silver coin are at 
a parity with gold coin. The Government notes 
are at a parity with gold because the Government 
has promised to pay them in gold, and keeps an 
adequate reserve of gold to insure their payment 
on demand. While the Government has not defi- 
nitely promised to redeem the silver dollars in 
gold, yet they are at a parity with gold because 
their supply is limited, because they are receivable 
for customs, taxes, and public dues, and because, 

23 



THE BANKING AND CURRENCY PROBLEM 

by Act of Congress, it is made the duty of the 
Secretary of the Treasury to maintain these silver 
dollars at a parity with gold. 

At the present day few persons would be so un- 
wise as to favor an increase of the issue of silver 
dollars, which are declared to be legal-tender 
money, though intrinsically worth only about fifty 
cents in gold. People have not yet forgotten that, 
not many years ago, the continued coinage of these 
silver dollars cost the country hundreds of millions 
of dollars, and by causing doubts as to the stability 
of the gold standard of value precipitated a great 
financial panic. It will be pointed out hereafter 
that the issue of additional Government notes 
would be equally dangerous and unwise, even 
though the Government should undertake to 
maintain a large gold reserve for their redemp- 
tion. 

If, then, the issue of more legal-tender silver 
dollars and Government notes be excluded, the 
only way of increasing the aggregate amount of 
money in the United States available as bank 
reserves is by adding to the stock of gold. As gold 
cannot be created by statute, it follows that the 
only practicable way of increasing the aggregate 
amount of money available as true bank reserves 
is by obtaining additional gold from the mines, 
or by importing it from abroad, either by means 

24 



IN THE UNITED STATES 

of foreign loans or by means of exports of cotton 
or grain or other property, or of stocks and bonds. 



Maintenance of the Gold Standard and of Cash Payments 

There is a radical difference between the main- 
tenance of the gold standard of value and the 
maintenance of cash payments by the banks. 
Maintenance of the gold standard of value means 
that all the legal-tender currency other than gold — 
in other words, the Government notes, or green- 
backs, and the silver currency — shall be kept at 
a parity with gold, so that any one having Govern- 
ment notes or silver dollars and desiring gold, can 
obtain for the Government notes or silver dollars 
an equal sum in gold dollars. It means that all 
paper and silver currency, which debtors are re- 
quired by law to accept in payment of their claims, 
shall be maintained at a value equal to gold coin, 
so that debts cannot be paid in a depreciated cur- 
rency. On the other hand, maintenance of cash 
payments by the banks means that the banks 
shall continue to perform their contracts to pay 
their depositors and note-holders on demand in 
any kind of currency in which the bank deposits 
are payable. 

If there were no Government notes and no silver 
in our currency — if gold were the only legal-tender 
3 25 



THE BANKING AND CURRENCY PROBLEM 

money of the United States — no question ever 
could arise as to the maintenance of the gold dollar 
as the standard of value. A default on the part 
of the banks to pay their deposit liabilities on de- 
mand would not in the least affect the standard of 
value. Under these circumstances the deposit 
liabilities of the banks might fall in value and 
might sell at a discount, but the standard of value 
would remain unchanged. During the recent panic, 
when the banks suspended payments, gold and 
other lawful money at one time was quoted at a 
premium of three per cent.; but of course this 
did not mean really that gold had risen to a pre- 
mium and that the standard of value had changed. 
It meant that the obligation of the banks to pay 
depositors on demand (which obligation was in 
default and could not be collected for the time 
being) had fallen below its face value. It meant 
that a check on a bank for one hundred dollars 
was worth only about ninety-seven dollars in actual 
cash, because cash was wanted and the bank could 
not, or would not, on demand, pay the check in 
cash. 

The issue of notes by the banks would not affect 
the standard of value, though the banks should 
suspend payment and the notes fall to a discount, 
unless the bank-notes were made a legal tender. 
A person entitled to a sum of money could refuse 

26 



IN THE UNITED STATES 

the notes and could insist upon payment in gold 
or other lawful money, or he could accept bank- 
notes at their current depreciated value. Before 
the war many issues of bank-notes were current 
at various rates of discount, but nevertheless the 
gold standard of value remained unchanged. 



Issue of Bank-Notes 

While there is no practicable way of increasing 
the aggregate amount of lawful money in the 
country except by digging gold out of the ground 
or by importing it from abroad, there is a way of 
rendering available as bank reserves part of the 
gold and other lawful money already in circulation 
among the people. This result can be brought 
about through the issue of bank-notes, which are 
merely promissory notes of the banks to pay law- 
ful money to bearer on demand. 

If the public have entire confidence that when- 
ever these notes are presented for payment lawful 
money can be obtained in exchange, people will 
accept the notes as equivalent to lawful money and 
the notes will serve as a circulating medium in 
place of lawful money. The lawful money in place 
of which the bank-notes are used as a circulating 
medium thereby is made available as a reserve for 
the banks, Though the aggregate amount of law- 

27 



THE BANKING AND CURRENCY PROBLEM 

ful money good as bank reserves cannot be in- 
creased by an issue of bank-notes, the portion of the 
existing lawful money available as bank reserves 
may be increased by substituting bank - notes for 
lawful money in circulation. 



Effects of Issuing Bank-Notes 

When the deposit liabilities and loans of the banks 
already are expanded to the limit of safety, having 
regard to their reserves, a withdrawal of lawful 
money from the reserves may cause an enormous 
shrinkage of the credit power of the banks. On 
the basis of the average expansion of bank credits 
in relation to reserves, the withdrawal of $100,- 
000,000 of reserve money may involve a shrinkage 
of more than $500,000,000 in the credit power of 
the National banks alone, and a shrinkage of more 
than $1,000,000,000 in the collective credit power 
of all the banks and trust companies. If, how- 
ever, when an unusual amount of currency is de- 
manded by the public for use as a circulating 
medium, the banks could issue notes instead of pay- 
ing out lawful money from their reserves, they could 
by this means prevent the depletion of their reserves 
and could avoid the necessity of reducing largely 
their loans and discounts and their deposit liabili- 
ties. Therefore, the issue of bank-notes is a potent 

28 



IN THE UNITED STATES 

means of preventing a reduction of reserves and a 
contraction of the credit power of the banks when an 
unusual amount of currency is needed for circulation. 
The issue of bank-notes is available, not only as 
a means of preventing a reduction of the reserves 
of the banks and the consequent large contraction 
of their credit power, but also as a means of in- 
creasing bank reserves, and of causing a large ex- 
pansion of the power of the banks to grant credits. 
If, when there is no demand for an unusual amount 
of circulating currency, bank-notes could be issued 
and kept in circulation in substitution for lawful 
money, the lawful money displaced by the notes- 
would accumulate in the banks, thereby increasing 
their reserves and causing a large increase of their 
power to grant credits. If $100,000,000 of bank- 
notes could be put out and kept in circulation in 
place of a like amount of lawful money, this law- 
ful money would be added to the bank reserves and 
the credit power of the banks would be increased 
more than $500,000,000, according to the present 
average expansion of credits of the National 
banks, and more than $1,000,000,000, according 
to the present average of all the banks and trust 
companies. In the case of State banks and trust 
companies which are permitted to hold National 
bank-notes as reserves, it would not be necessary 
even to go through this process of substituting the 

29 



THE BANKING AND CURRENCY PROBLEM 

bank-notes for lawful money in circulation. The 
notes would be an addition to the amount of cur- 
rency in the country directly available as reserves 
for these State banks and trust companies. 

In order to serve their purpose, bank-notes must 
be kept at a parity with gold and other lawful 
money. As long as this parity continues, it is 
immaterial to the people at large whether they re- 
ceive lawful money or bank-notes, and rarely, if 
ever, do the public present bank-notes for redemp- 
tion in lawful money. The National banks, how- 
ever, always prefer lawful money, because lawful 
money is good as a reserve, whereas bank-notes are 
not good for that purpose. For that reason the 
National banks, whenever practicable, keep law- 
ful money and pay out their own notes, or the 
notes of other banks. 

When the people have in their possession more 
currency than they need, they deposit the excess 
in the banks, without discriminating between lawful 
money and bank-notes, which to them are of equal 
value. The National banks, however, assort this 
currency and, whenever practicable, keep the re- 
serve money, while paying out notes to depositors 
who call for currency. A constant process of sift- 
ing the currency thus goes on — the lawful reserve 
money being accumulated by the banks w T hich 
put the notes in circulation in place of reserve 

30 



IN THE UNITED STATES 

money. When there is a demand for an unusual 
amount of currency for use as a circulating medium, 
the banks, if they have power to issue notes, pay 
out notes to meet this increased demand. When 
the additional currency thus created is no longer 
needed, people do not pick out the bank-notes and 
return them to the banks and keep the reserve 
money in circulation, but, to the extent of the 
excess of currency in circulation, the reserve money 
and the bank-notes are deposited indiscriminately. 
The banks again sift the currency so deposited and 
retain the reserve money, but when currency is 
demanded for use as a circulating medium they 
again pay out notes. 

This process of substituting bank-notes for law- 
ful reserve money in circulation goes on continually, 
and is bound to go on so long as the National banks 
prefer to pay out bank-notes rather than reserve 
money, and the public are indifferent whether they 
receive notes or reserve money. Through this 
process about six hundred million dollars of Na- 
tional bank-notes are kept outstanding year in, 
year out, even when the aggregate amount of the 
currency is unnecessarily large and when interest 
rates have fallen to a minimum. It is through this 
process that practically all the gold in Canada has 
been accumulated in the banks, while the currency 
in circulation among the people consists almost 

3i 



THE BANKING AND CURRENCY PROBLEM 

entirely of bank-notes, subsidiary silver, and small 
Government notes. 

Facility of redemption of bank-notes would not 
prevent this process of substituting bank-notes for 
lawful reserve money in circulation, because as long 
as bank-notes are worth as much as other currency 
the public do not present notes for redemption ; and 
when a bank presents notes to another bank for re- 
demption this operates merely as a transfer of re- 
serve money from one bank to another bank. No 
doubt if bank-notes could be redeemed in lawful 
money, promptly, and without expense to the holder, 
each National bank receiving notes of other banks 
would present them for redemption instead of accu- 
mulating them in its vaults. But this would not 
diminish the amount of notes in circulation among 
the people, or tend to check the gradual substitution 
of notes for lawful money in circulation as long as 
the banks can issue notes and lawful money re- 
mains in circulation. It is to be borne in mind, 
also, that State banks and trust companies which, 
by law, can hold National bank-notes as reserves 
would have no incentive to present the bank-notes 
for redemption in lawful money. 

Difference between Notes and Other Instruments 

In recent discussions it has been urged by high 
authority that, as a bank-note represents merely 

32 



IN THE UNITED STATES 

a liability of the issuing bank to pay on demand 
a specified sum, an issue of bank-notes has the 
same effect as the creation of a like amount of 
deposit liabilities, or the issue of cashier's checks 
or certificates of deposit; and that undue expan- 
sion of bank credits through the issue of bank- 
notes can be prevented by requiring the banks 
to keep against their outstanding notes the same 
reserves as against their deposit liabilities. This 
appears to be a dangerous error. By issuing 
circulating notes the banks, indirectly, may in- 
crease their reserves of lawful money and their 
credit power in a way that is not possible by means 
of cashier's checks or certificates of deposit, or by 
means of checks drawn upon the banks by de- 
positors. It is true that the liability of a bank to 
pay its notes on demand is essentially the same as 
its liability to pay its cashier's checks or certificates 
of deposit, or its liability to pay checks of its de- 
positors ; but bank-notes are a practical substitute 
for lawful money as a circulating medium, whereas 
certificates of deposit, cashier's checks, and checks 
drawn by bank depositors are not available for 
that purpose, except to a limited extent. Theo- 
retically, it might be possible to dispense with the 
use of our present currency as a circulating medium 
and to use only cashier's checks, certificates of de- 
posit, or checks drawn by bank depositors; but 

33 



THE BANKING AND CURRENCY PROBLEM 

we know that the people of the United States al- 
ways require the use of more than fifteen hundred 
million dollars of gold, silver, greenbacks, or bank- 
notes, and that neither checks nor certificates of 
deposit are a practical substitute for this currency 
required by the people. In practice it is not pos- 
sible for the banks to prevent a depletion of their 
reserves and a resulting money stringency by offer- 
ing to issue cashier's checks or certificates of de- 
posit in lieu of paying out currency when currency 
is demanded. For the same reason cashier's checks, 
certificates of deposit, and checks drawn by bank 
depositors cannot drive lawful money out of cir- 
culation into the National bank reserves. By 
issuing circulating notes to take the place of lawful 
money in circulation the banks may cause an in- 
crease of their reserves and a large expansion of 
their power to grant credits, but no such conse- 
quences can result from the issue of cashier's checks 
or certificates of deposit, or by the creation of de- 
posit liabilities, for these are not practical sub- 
stitutes for lawful money as a circulating medium. 

Regulation of the Banks 

In the main, the banks in the United States have 
been managed honestly and with signal ability, 
and they have served the country well The ulti- 
mate losses of depositors in the banks and the trust 

34 



IN THE UNITED STATES 

companies have been remarkably small, having 
regard to the fact that there are approximately 
twenty thousand banks and trust companies doing 
a banking business, and that many of them were 
established in newly developed sections of the 
country by men who had little or no previous 
experience as bankers. 

The main causes of failures of individual banks 
are dishonesty, bad business judgment, and over- 
expansion of liabilities in relation to reserves. 
Dishonesty and bad business judgment never can 
be wholly prevented by statute. No legislation can 
make bank managers honest and wise, or prevent 
occasional bank failures resulting from dishonest 
or foolish management. Sound judgment and a 
large measure of discretion are essential to the suc- 
cessful management of the banking business, and 
any attempt, by statutory rules and regulations, 
to prevent bank managers from committing errors 
of judgment or abuses of discretionary powers is 
bound to prove a failure. 

However, there are practices that ought to be 
prohibited by law because they tend to errors of 
judgment or to actual fraud. Thus the laws should 
prohibit the managing officers of a bank from bor- 
rowing from their bank or from dealing with it, 
directly or indirectly, for their own benefit; and 
also should prohibit dealings between a bank and 

35 



THE BANKING AND CURRENCY PROBLEM 

a company in which its managing officers are per- 
sonally interested. Furthermore, the best prac- 
ticable provision should be made for the prompt 
discovery and prevention of dishonest or unsound 
banking methods. The examinations of the banks 
by the Comptroller should be made more thorough, 
and statutory authority should be given to the 
clearing-house associations in the various cities to 
examine the affairs of their members and to ex- 
ercise a large measure of supervision, including 
power to stop any course of business that is im- 
prudent even if lawful. 



Insufficient Reserves and Over-Expansion of Credits 

The question of the sufficiency of bank reserves, 
or, in other words, how far the banks can safely 
expand their liabilities in relation to reserves, must 
be considered in two aspects. It must be con- 
sidered with regard to the position of each bank 
severally, and it must be considered also with re- 
gard to the position of all the banks collectively 
and to the entire credit situation. 

The sufficiency of the reserves of any particular 
bank, considered without regard to the entire credit 
situation, depends largely upon the character of 
the deposit liabilities and assets of the bank. Thus, 
as a rule, safety would require a bank to keep on 



IN THE UNITED STATES 

hand against very large deposits of single depositors 
a larger percentage of reserve than against an equal 
aggregate of small deposits of many depositors, 
for the danger that the reserves of a bank may 
be exhausted by the withdrawal of a few large 
deposits is greater than that of exhaustion by 
the withdrawal of a large number of small 
deposits. Again, safety would require reserves 
against deposits that fluctuate widely in amount, 
or that are known to be only temporary, to be 
larger than those against deposits of a more per- 
manent character. For this reason reserves against 
deposits of other banks and against deposits of 
stock-brokers, or others engaged in a fluctuating 
or uncertain business, should be larger than those 
against savings deposits or against ordinary mer- 
cantile deposits. Again, the character of a bank's 
loans and investments has an important bearing 
upon the sufficiency of its reserves, considered with- 
out regard to the credit situation as an entirety. 
Thus, under normal financial conditions, a bank 
whose bills receivable consist largely of good call 
loans convertible promptly into cash, or of good 
short-time commercial paper maturing from day 
to day, would be safe with a smaller amount of 
cash in its vaults than a bank whose assets consist 
largely of time loans or other investments that can- 
not be converted promptly into cash. 

37 



THE BANKING AND CURRENCY PROBLEM 

It follows that the question how far any par- 
ticular bank may safely expand its liabilities in 
relation to reserves is a question of sound business 
judgment, and can be determined only by those 
familiar with the entire business of the bank and 
with the character of its deposits and of its assets. 
For this reason it has not been found advisable 
in foreign countries to prescribe, by statute, 
the minimum reserves which each individual 
bank shall keep in relation to its deposit liabil- 
ities. 



Minimum Reserves of National Banks 

The statutory minimum reserves of the National 
banks vary according to location. National banks 
in central reserve cities — i.e., New York, Chicago, 
and St Louis — are required to keep in their vaults 
an amount of lawful money equal to 25 per cent, 
of their deposit liabilities. Banks in reserve cities 
are required to keep reserves nominally equal to 
25 per cent, of their deposit liabilities, but of these 
reserves only one-half need be in lawful money, 
and the other half may be in the form of deposits 
with banks in central reserve cities. Country banks 
are required nominally to keep reserves equal to 
1 5 per cent, of their deposits, but of these reserves 
three-fifths may be in the form of deposits with 

33 



IN THE UNITED STATES 

banks in reserve cities or central reserve cities and 
only two-fifths need be lawful money. 

This classification appears to be based upon no 
sound principle and, from every point of view, to 
be arbitrary. If the object of requiring the banks 
to keep minimum reserves is to provide for the 
safety of the entire credit situation, no deposits 
of banks with other banks should be counted as 
reserves. Deposits of one bank with another bank 
do not augment the total reserves of the banks 
available for the payment of all their deposit lia- 
bilities, and do not in the least strengthen the gen- 
eral credit situation. Such deposits merely enable 
some banks to strengthen their reserves by ex- 
hausting pro tanto the reserves of other banks. If, 
however, the object is to provide for the safety of 
the several banks considered individually, without 
regard to the general credit situation, then no test 
is furnished by the location of the several banks, 
whether in a central reserve city, or in a reserve 
city, or elsewhere. The ability of a bank to pay 
its depositors, on demand, in cash, depends, not 
upon the location of the bank, but upon the nature 
of its assets and of its deposit liabilities. Again, 
if the object is to provide for the ultimate security 
of bank depositors, and not merely for the ability 
of the banks on demand to pay cash, then the test 
of safety would be a comparison of the amount of 

39 



THE BANKING AND CURRENCY PROBLEM 

the capital and surplus of the bank with its lia- 
bilities, because the capital and surplus of a bank 
is the only margin of security for the ultimate pay- 
ment of its liabilities. 

The framers of the National Banking Act re- 
quired the reserve city banks to carry cash reserves 
larger than those of the country banks, probably, 
because it was contemplated that the country 
banks would keep part of their reserves in the form 
of deposits with the reserve city banks, and that 
the reserves of the latter thus would serve as re- 
serves not only for their own deposit liabilities, 
but also in part for those of the country banks. 
The banks in the central reserve cities were re- 
quired to keep their 25 per cent, reserves wholly in 
cash, probably, because it was contemplated that 
the reserve city banks would keep half of their 
minimum reserves in the form of deposits with 
central reserve city banks, and that the reserves 
of the latter thus would constitute, in part, ulti- 
mate reserves for all the banks. It is obvious, 
however, that if a bank in a reserve city, or in a 
central reserve city, does not owe deposits to other 
banks, and if its deposits consist principally of 
steady commercial deposits, safety would not re- 
quire it to keep as high a percentage of reserve as 
a bank that owes deposits to other banks. For 
the purpose of ascertaining the collective condi- 

40 



IN THE UNITED STATES 

tion of the banks and the general credit situation, 
the system established by the National Banking 
Act, and the reports of the Comptroller under this 
Act, at best, are misleading, because part of the 
reserve money held by the banks is counted twice, 
and some of it three times. 

Therefore, it is desirable to reconsider and revise 
the provisions of the National Banking Act, pre- 
scribing the minimum reserves to be kept by the 
various banks. Having regard to the general bank- 
ing situation, deposits of one bank in another bank 
should not be counted as reserves. Money is the 
only ultimate bank reserve. Having regard to the 
safety of the several banks considered separately, 
the minimum reserves of the banks should be deter- 
mined, not by their location, but by the character 
of their deposits and of their assets. 

A sounder plan would be to require the banks 
to keep against deposits of other banks and of trust 
companies minimum reserves higher than those 
against ordinary deposits of individuals, and to 
require the whole of the minimum reserves to be 
kept in lawful money in the banks. For example, 
it might be provided that all National banks shall 
maintain lawful money reserves amounting to 30 
per cent, of such of their deposits as may be owing 
to other National banks, State banks, trust com- 
panies, and private bankers, and 10 per cent, of 
4 41 



THE BANKING AND CURRENCY PROBLEM 

all other deposits, with power in each clearing- 
house association, upon obtaining the approval of 
the Comptroller of the Currency, to increase the 
latter percentage, temporarily, as to all or any 
banks that are members of the clearing-house 
association. It might be provided, also, that no 
bank may incur deposit liabilities to an amount in 
the aggregate exceeding five times the amount of 
its capital and surplus. The foregoing percent- 
ages are indicated, not for adoption, but merely 
for the purpose of showing how the reserve require- 
ments of the banks could be placed upon a sounder 
basis. 

Necessarily, any statutory rule must be arbitrary, 
for the extent to which a bank can safely expand 
its liabilities depends largely upon the character of 
its loans and other assets, and upon its entire busi- 
ness. Unfortunately, in the United States an im- 
pression has grown up that because certain mini- 
mum reserves are prescribed by law any bank safely 
may make loans (especially call loans) and may 
create deposit liabilities to any extent found prof- 
itable, if only the minimum reserves prescribed by 
law be maintained. If this impression had not 
grown up in the United States, and if our bankers, 
to the same extent as bankers in Europe, were 
governed by conservative traditions, there would 
be strong arguments in favor of adopting the 

42 



IN THE UNITED STATES 

foreign plan to fix no minimum reserves by statute, 
but to allow the managers of each bank, from time 
to time, to determine what reserve the bank shall 
keep. However, under existing conditions, prob- 
ably it would be unwise to adopt the foreign plan 
and to abolish all statutory reserve requirements. 



Over-Expansion with Regard to the General Credit 
Situation 

The managers of each bank have the power to 
regulate the amount of its loans and discounts and 
the expansion of its deposit liabilities in relation to 
reserves, having regard to the condition of the par- 
ticular bank which they control ; but in the United 
States bank managers have no power to regulate 
the expansion of credits of all the banks with a view 
to the security of the general credit situation, and 
have no power, through the issue and redemption 
of bank-notes, to prevent sudden and wide fluctua- 
tions of the credit power of the banks resulting from 
the fluctuations of the volume of currency used as a 
circulating medium. Though the managers of 
fifty, or of a hundred, out of the seven thousand 
National banks may be of the opinion that, having 
regard to existing or prospective conditions, the ex- 
pansion of credits has gone too far, they have no 
power to accomplish any substantial result. They 

43 



THE BANKING AND CURRENCY PROBLEM 

could restrict the grant of credits by their own banks 
and so lose profitable business that would go to 
other banks, but they could not materially improve 
the general situation. This was the case prior to 
the recent panic. For months before the panic 
many intelligent managers of banks and trust com- 
panies knew that the credit situation throughout 
the country had become strained, and accordingly, 
by restricting credits and by making call loans in- 
stead of time loans, many of them endeavored to 
strengthen their own institutions, but they could 
do little for the protection of the general credit 
situation. 

The main problem of the National Monetary Com- 
mission is to devise an adequate means of regulat- 
ing and of protecting the general credit situation, 
so as to avoid sudden and wide fluctuations in the 
amount of credit available for the transaction of the 
business of the country. The regulation of the 
banks, severally, with a view to the prevention of 
dishonesty and unsound banking practices, and the 
regulation of reserves with regard to the condition 
of the several banks considered separately, are 
matters of minor importance. The reserves and 
the expansion of credits of each separate bank can 
be regulated intelligently only by the officers of the 
bank conversant with its condition and the charac- 
ter of its business. Even if some of the banks oc- 

44 



IN THE UNITED STATES 

casionally should expand ther liabilities too far in 
relation to their reserves, no great harm would 
result if the banks throughout the country, con- 
sidered collectively, have not over-expanded. If 
bank credits generally have not been over-expanded, 
as was the case during the recent panic, when all 
the banks had to suspend, any individual bank that 
has a sufficient amount of good bank assets usually 
can replenish its reserves and relieve its difficulties 
by selling part of its assets, or by borrowing from 
other banks. 



Central Regulation Necessary 

The point to which bank credits throughout the 
country may be expanded with safety depends upon 
many circumstances and varies from time to time. 
A ratio of reserves to liabilities may be perfectly 
safe under certain conditions and quite unsafe 
under other conditions. It is a fatal mistake to 
assume that bank credits always can be expanded 
with safety to the maximum allowed by the reserve 
requirements of the National Bank Act. Recent 
experience has shown that though the minimum 
reserves required under the National Bank Act are 
sufficient in ordinary times, they are not sufficient 
at all times, and that credits may be expanded 
beyond the limit of safety although the legal ratio 

45 



THE BANKING AND CURRENCY PROBLEM 

of reserves to liabilities be maintained. It is not 
sufficient to consider merely the rate of interest in 
Wall Street. It is not sufficient to consider the 
rate of interest and financial conditions throughout 
the United States. It is necessary to consider the 
whole world. The financial and commercial rela- 
tions between the leading countries of the world 
are so close that any shock affecting financial condi- 
tions in one country would be felt by them all. 
A great war, or a financial crash in any country, 
would affect financial conditions throughout the 
whole civilized world. 

It is necessary to consider, also, the prospective 
expansion of business and the prospective demand 
for credits and for currency throughout the world. 
Furthermore, allowance must be made for events 
that cannot be foreseen. There are times when 
exceptional conditions render necessary an ex- 
ceptional expansion of bank credits, or of the cur- 
rency, as a temporary measure of relief, as, for ex- 
ample, when a panic is threatened by reason of the 
sudden withdrawal of currency in unusual amounts 
to be hoarded by depositors who have lost con- 
fidence in the banks. In such case, however, safety 
would require that, as soon as the immediate need 
of the extraordinary expansion shall have been 
removed, bank credits and the currency shall again 
be contracted to a normal limit. 

46 



IN THE UNITED STATES 

The currency situation, also, is a condition hav- 
ing an important bearing upon the safety of further 
expansion of the currency by the issue of bank- 
notes, or of further expansion of bank credits in 
relation to reserves. If, by reason of great activity 
in business or other cause, an unusual amount of 
currency is in circulation, the ratio of reserves to 
deposit liabilities may, with safety, be lower than 
when only a normal amount of currency is in circula- 
tion and there are grounds for anticipating, in the 
near future, additional withdrawals of currency for 
use as a circulating medium. Moreover, a ratio of 
reserves to liabilities that would be safe when little 
or no bank-note currency is in circulation may be 
perilously unsafe when a large part of the currency 
in circulation consists of bank-notes, because, under 
such conditions, bank credits already have been 
expanded by the substitution of notes for money 
as a circulating medium. 

There is no country in the world where the volume 
of currency in circulation and the demand for bank 
credits fluctuate more widely than in the United 
States. This is due to the great expanse of our 
territory, to the annual harvest requirements of the 
agricultural sections, to the prevailing business 
activity and enterprise, and to the rapid and un- 
equal increase of population and wealth in different 
sections. Furthermore, there is no country in the 

47 



\ 



THE BANKING AND CURRENCY PROBLEM 

world where intelligent control over bank credits 
and bank reserves is needed more than in the 
United States. There are in the United States 
nearly seven thousand National banks, besides 
twice as many State banks and trust companies. 
Each of these institutions acts for its individual 
interest alone, independently of the others, and 
the prevailing tendency of each at all times is to 
expand its credits to the limit permitted by law. 
The country banks lend their surplus resources in 
the form of deposits at interest to the banks in the 
larger cities, and the banks in the principal money 
centres commonly expand their credits as much as 
practicable by lending on call such sums as they 
deem it unsafe to lend on time or by discount of 
commercial paper. Each bank with a deposit in 
another bank assumes that, in case of need, it can 
strengthen its reserve by drawing upon this de- 
posit; but it fails to consider that, when thus it 
strengthens its own reserve, it must to the same 
extent weaken the reserve of the other bank, and 
that the deposits of banks with other banks add no 
strength to the general credit situation. Each 
bank that has loaned money on call assumes that, 
in case of need, it can strengthen its reserve by 
calling such loans; but it fails to consider that, 
generally, when a loan is called the borrower is 
obliged to borrow the same sum from some other 

48 



IN THE UNITED STATES 

bank, although a high rate of interest may be ex- 
acted, and, therefore, that call loans affect the 
security of the entire bank situation practically to 
the same extent as time loans. 

In the United States there is no way of regulat- 
ing the supply of bank credits and of holding part 
of the potential supply in reserve for periods of 
financial stringency. Consequently, nearly always 
there is either an over-abundance of money (mean- 
ing credit which the banks are ready to lend) or a 
money famine. It has been argued that the vol- 
ume of credits granted by the banks depends upon 
business activity and upon the consequent demand 
for credit and not upon the power of the banks to 
grant credits, and, therefore, that low interest 
rates have little effect in causing an expansion of 
bank credits. Experience, however, shows that the 
contrary is the case, at least in the United States. 
It is true that, when there is loss of confidence and 
when business is depressed, interest rates are low, 
because there is less currency in circulation and 
more in the bank reserves, while at the same time 
the demand for bank credits is diminished. It is 
true, also, that low interest rates will not stimulate 
speculation and enterprise unless people have con- 
fidence and are ready to speculate and to embark 
in new enterprises. But we know by experience 
that when people are in a mood for speculation and 

49 



THE BANKING AND CURRENCY PROBLEM 

for business expansion low interest rates operate 
as a powerful stimulus to speculation and business 
expansion. A leading banker has said: "In the 
long run commerce suffers more from the periods of 
over-abundance (of money) than from those of 
scarcity. The origin of each recurring period of 
tight money can be traced to preceding periods 
of easy money. Whenever money becomes so 
over-abundant that bankers, in order to keep it 
earning something, have to force it out at abnor- 
mally low rates of interest, the foundations are 
laid for a period of stringency in the not far dis- 
tant future, for then speculation is encouraged, 
prices are inflated, and all sorts of securities are 
floated until the money-market is glutted with 
them."* 



The Central Bank Plan 

The leading nations of Europe have learned by 
experience that no rule of mechanical application 
can be laid down and no automatic system can be 
devised, and that the only practicable way of reg- 
ulating the general expansion of bank credits so 
as to provide for exceptional conditions, as well as 
for the ordinary requirements of commerce, is to 

* From an address by Mr. James B. Forgan to the Texas 
Bankers' Association. 

So 



IN THE UNITED STATES 

invest boards of experienced men with some meas- 
ure of power to control the expansion of bank 
credits, and in particular with the power to regulate 
the issue of bank-note currency. In each of these 
countries the regulation of the credit situation is 
effected by means of a large central bank, which, 
subject to Governmental control, is considered 
charged with general supervision of financial condi- 
tions. The systems of banking and currency adopt- 
ed by the leading commercial nations of Europe 
differ in various particulars, but all have in common 
this one feature — a large central bank vested with 
some measure of power to control the general ex- 
pansion of bank credits. This control can be exer- 
cised by the central bank in the following manner : 

(i) By acting as a bank for the discount of com- 
mercial paper, and by raising or lowering its dis- 
count rate, the central bank, to a certain extent, 
can regulate interest rates and the expansion of 
credits throughout the country and the flow of 
gold to or from the country. It is by this method 
that the Bank of England regulates the credit 
situation in England. 

(2) By issuing its notes the central bank can 
prevent a withdrawal of bank reserves for use as 
circulating currency and a consequent financial 
stringency, and by diminishing the volume of its 
outstanding notes it can check over-expansion 

5i 



THE BANKING AND CURRENCY PROBLEM 

when the occasion for the issue of the notes has 
passed. The central banks of France and of Ger- 
many regulate financial conditions by this method 
as well as by changing their discount rate. 



Central Bank Not Practicable in the United States 

Many able bankers are of the opinion that in the 
United States we should secure the necessary cen- 
tral control over the expansion of bank credits, 
and should provide for the stability of financial 
conditions by adopting the European plan — name- 
ly, by establishing a great central bank. 

In order to accomplish the desired purpose by 
means of a central bank, it would be necessary to 
create a bank of colossal magnitude and to confer 
upon it a monopoly of the power to issue bank-note 
currency. The eminent Senators and Congressmen 
who constitute the National Monetary Commission 
will be best able to judge whether it would be politi- 
cally practicable to secure the enactment of the leg- 
islation necessary to establish such a bank. In the 
opinion of the writer it would be impossible. Our ex- 
perience with the former Bank of the United States 
shows that the people of the United States would 
not consent to the creation of such a central bank. 
The people could not be convinced that it would 
be desirable, or that it would be safe to give to any 

5 2 



IN THE UNITED STATES 

man or to any set of men the power to control the 
vast resources of such a bank, and to dominate all 
the banks and business interests of the country. 

However, even if it were practicable to obtain 
the necessary legislation, it would not be desirable 
to establish such a great central bank. The prac- 
tical control of such a bank, as in the case of every 
successful institution of that kind, would soon pass 
into the hands of one man or of a very small num- 
ber of men. Although, to-day, the best man or set 
of men might be in control, there would always be 
danger that the control might pass into undesirable 
hands. And even though provision could be made 
so that the control of such a bank always would re- 
main in the hands of the wisest, the most honor- 
able, and the most disinterested men, it would not 
be possible to satisfy the people throughout the 
country that the vast resources and powers of the 
bank were used only for the best interests of all the 
people and without partiality or favor to any sec- 
tion of the country, or to any class or set of people. 
The administration of such a bank would be a 
source of endless sectional differences and dissen- 
sions, and soon it would become a political issue. 
The South would want the bank, by means of loans, 
to help the planters to accumulate and to carry 
their crops of cotton and tobacco so as to force 
higher prices. The West would want the bank to 

53 



THE BANKING AND CURRENCY PROBLEM 

use its resources to enable the farmers to raise the 
price of corn and wheat. The large money centres 
would want the bank to help bankers and brokers 
to carry stocks and bonds when speculation runs 
high at the stock-exchanges. Claims would be 
made on the one hand that the bank was unduly 
favoring the country banks, and on the other hand 
that it was unduly favoring the banks in the large 
cities. In every period of financial stringency and 
of high interest rates, an outcry would come from 
every part of the country that the central bank 
should relieve the situation ; and if the managers of 
the bank should deem it unsafe to yield to this 
outcry by expanding credits still further, their re- 
fusal to act would be charged to selfish motives, or 
to collusion with the so-called money interests of 
Wall Street. We have not the traditions which in 
foreign countries have established public con- 
fidence in the management of their great central 
banks and have made them useful and desirable 
institutions. 

A great central bank would be out of harmony 
with our business habits and our political methods. 
Centralization of power undoubtedly furnishes an 
effective means of accomplishing things in business 
as well as in politics. Results that can be effected 
easily by an autocrat can be obtained only with 
difficulty and haltingly by individual effort and 

54 



IN THE UNITED STATES 

under a system of popular government. But if, 
in order to preserve our institutions, we must lose 
some of the advantages of great centralization of 
power in business as well as in matters of govern- 
ment, the price is not too high. 

For these reasons it is submitted that in the 
United States the central bank plan is not prac- 
ticable or desirable, and that the desired central 
regulation should be attained by other methods. 



Independent Bank-Note Issues 

Divers plans have been proposed for the regula- 
tion of the credit situation in the United States by 
the issue and redemption of notes of the various 
banks, and it has been argued that, were facilities 
adequate for the speedy redemption of the notes, 
satisfactory regulation of the amount of the cur- 
rency and of the expansion of bank credits would 
result automatically. The objection to these plans 
is that they furnish facilities for expansion, but fail 
to provide against over-expansion and furnish no 
means of regulating the credit situation. 

It has been asserted that in Canada and in Scot- 
land the power to issue credit currency has been 
given to the several banks without any central 
control and that in those countries the system has 
worked well. In all Scotland there are but eight 

55 



THE BANKING AND CURRENCY PROBLEM 

banks, each having numerous branches, and their 
aggregate note issues do not exceed fifty million 
dollars. In Canada there are but thirty-four banks, 
each also having numerous branches, and their 
aggregate note issues vary from seventy to a hun- 
dred million dollars. Both in Scotland and in Can- 
ada the banks act in harmony in carrying out an 
agreed policy. Yo argue that because this system 
of independent bank-note issues works satisfactorily 
in small and conservative Scotland, with its eight 
banks under the wing of the great central Bank of 
England, and in Canada, with its thirty-four banks 
acting in concert, therefore the same system would 
work satisfactorily in a country as large as the 
United States, with twenty thousand independent 
banks and trust companies, including seven thou- 
sand National banks having deposits of more than 
five thousand million dollars and already having 
outstanding bank-notes amounting to about six 
hundred million dollars, exhibits a large measure 
of optimism and little regard for the judgment 
of other nations and for the lessons of our own 
experience. 

The great commercial nations of the Old World, 
England, France, and Germany, have not found it 
safe or practicable to give to all the banks the power 
to issue circulating notes as in Scotland and in 
Canada. Our own experience indicates the re- 

56 



IN THE UNITED STATES 

suit that would follow were the power to issue ad- 
ditional notes to be given to each of the seven 
thousand National banks in the United States, free 
from central control. The result would be that, 
at all times, each bank, without regard to the 
general credit situation, would put out as many 
notes as practicable, and thus there would be in- 
jected into the currency a wholly unelastic — that is 
to say, non-contracting — issue of bank-notes. This 
is precisely what has happened in consequence of 
giving to the banks the power of issuing their pres- 
ent bond-secured notes. These notes are redeem- 
able at the will of any holder who wants to redeem 
them, but by experience we know that individuals 
do not present bank-notes for redemption, and that 
the banks always are trying to keep them in circula- 
tion. The same result would follow if the banks 
were authorized to issue credit notes, or any other 
form of bank-note currency that has been proposed, 
free from intelligent central control. 

As has been pointed out, facilities for obtaining 
the redemption of bank-notes would not prevent the 
substitution of notes for lawful money in circulation, 
but would prevent only the accumulation of notes 
in the vaults of the National banks. The amount 
of notes in circulation would increase as long as the 
banks could issue notes and as long as there was 
lawful money in circulation that could be superseded 
s 57 



THE BANKING AND CURRENCY PROBLEM 

by bank-notes and collected in the bank reserves. 
The desired elasticity of the currency would not 
be brought about until practically all the lawful 
money in circulation was collected in the banks, 
only bank-notes remaining in circulation. This is 
the situation in Canada. The reason why the note 
issues of the Canadian banks contract as well as 
expand with the demand for circulating currency 
is that practically all the gold has been driven out 
of circulation into the banks, while only bank-notes, 
subsidiary silver coin, and small Government notes 
are used as circulating currency. 



The Currency Situation in the United States 

According to the report of the Comptroller of the 
Currency for 1907, the aggregate amount of gold 
coin in the United States on December 31, 1906, 
was $1,593,300,000, of which $1,081,500,000 was 
held in the United States Treasury (principally 
against gold certificates) and in the National banks, 
and $511,800,000 was in circulation. In the re- 
vised estimate of the director of the mint, on August 
1, 1907, the estimates previously published as to 
the amount of gold coin in circulation appear to 
have been reduced $135,000,000. Of necessity any 
statement as to the amount of gold actually in 
circulation must be a mere estimate or guess. The 

5* 



IN THE UNITED STATES 

coin in circulation cannot be counted, and the re- 
ports of the mints are not conclusive, as a con- 
siderable amount of gold coin is consumed in the 
arts or is carried out of the country. The paper 
currency and silver in circulation are subject also 
to gradual diminution through destruction and 
loss; but not much silver coin is consumed in the 
arts or carried out of the country, as the bullion 
value of silver dollars is only about one-half their 
coin value. 

The annual report of the Comptroller of the 
Currency contains a table purporting to set forth 
approximately, as of December 31, 1906, the stocks 
of gold, silver, and uncovered paper currency, and 
the amounts per capita in the principal countries of 
the world. The method of determining what 
portion of the paper currency in each country was 
uncovered is not explained, and it is not probable 
that in each case the same method was adopted. 
The amount of gold in circulation in the United 
States, certainly, was largely overestimated, and 
the amount of uncovered paper (being the National 
bank-notes and Government notes, less the coin 
reserved for their payment,) appears to have been 
understated. Nevertheless, the figures furnished 
in this table indicate: 

(1) That in the United States the currency con- 
tains a smaller percentage of gold and a larger 

59 



THE BANKING AND CURRENCY PROBLEM 

percentage of silver and paper than the currency in 
the United Kingdom, France, and Germany; 

(2) That in the United States the volume of un- 
covered paper currency is larger in proportion to 
the volume of gold and also larger per capita of 
population than in any of those countries ; and 

(3) That in the United States the percentage of 
the currency that does not consist of gold, but 
is declared legal tender and must be kept at a 
parity with gold, is larger than in any of those 
countries. 

If power were given to the individual banks in 
the United States to issue additional bank-notes, 
free from central control, each bank would issue and 
keep outstanding as many as practicable of these 
notes, and, for the reasons given in the preceding 
pages, the result would be to substitute bank-notes 
for legal reserve money in circulation and cor- 
respondingly to increase the bank reserves. The 
increase of the bank reserves effected in this man- 
ner would not of itself be harmful, but the ultimate 
consequences might be very serious. In the United 
States there are twenty thousand banks and trust 
companies, and each of these institutions, acting 
in its own interest without regard to the general 
credit situation, habitually makes loans and dis- 
counts and expands deposit liabilities to the utmost 
practicable extent whenever profitable. Judging 

60 



IN THE UNITED STATES 

by past experience, if through an issue of bank- 
notes the bank reserves should be increased, the 
banks would compete in expanding credits and 
in increasing loans and discounts to the utmost 
practicable extent, thereby causing interest rates 
to become excessively low. As a consequence, gold 
would be exported to countries where interest rates 
are higher and where the gold can be employed more 
profitably, while in the United States speculation 
would be stimulated and bank credits would be ex- 
panded until the reserves held by the banks and 
their power to grant credits shall have adjusted 
themselves according to the demand for credits. 

It may be urged that very low interest rates 
(which, however, would be only temporary) and 
exports of unnecessary gold would do no harm, 
and that it is sound economy to carry on the busi- 
ness of the country with as little gold as possible. 
It may be profitable, but it is not safe. The 
United States is the richest country in the world, 
and it can afford to use in its currency, relatively, 
as much gold and as little paper and silver as any 
other country, if, by so doing, it will increase the 
safety and stability of the general financial condi- 
tion. To-day, in the United States, relatively less 
gold and more silver and paper are used than in 
any of the other great commercial countries, al- 
though financial conditions are far less stable than 

61 



THE BANKING AND CURRENCY PROBLEM 

in those countries. It would not be prudent still 
further to diminish the percentage of gold in our 
currency in order to save the use of a compara- 
tively small amount of gold as a circulating medium, 
for this could be done only by substituting silver 
or notes for the gold. The immediate effect would 
be to cause an inflation of bank credits, and the 
ultimate effect would be to render less secure the 
maintenance of the gold standard of value and to 
weaken the foundation of the whole structure of 
bank credits in the country. 



Regulation by Taxation 

Plans also have been proposed to regulate the 
banking and currency situation by authorizing 
the National banks, in case of emergency, to issue 
additional notes for use as currency, upon pay- 
ment of a high tax imposed to prevent the banks 
from issuing the additional notes except during a 
period of severe money stringency. These plans 
are supposed to follow a German precedent which 
has worked with marked success, the Imperial Bank 
of Germany being allowed to issue its notes in ex- 
cess of a prescribed limit, only upon payment of a 
tax at the rate of 5 per cent, per annum. 

That these plans follow the German precedent 
is an error. If the German system were adopted, 

62 



IN THE UNITED STATES 

no doubt, we should have sounder financial con- 
ditions in the United States than exist to-day ; but 
the merit of the German system does not lie in 
the imposition of a 5-per-cent. tax on outstanding 
bank-notes. It lies in the adherence to sound 
banking methods and in the control of the bank- 
ing situation by the Imperial Bank. The Imperial 
Bank is a great central bank controlled by the 
Government, and is vested with the power as well 
as with the duty to regulate and to protect financial 
conditions throughout the empire. It commonly 
holds reserves amounting to 40 per cent, of its 
aggregate deposit liabilities and note issues. Even 
in times of money stringency, the uncovered note 
issues of the German banks, both absolutely and 
per capita of population, are less than one-half 
as large as the uncovered note issues of the 
National banks outstanding at all times. Fur- 
thermore, never under any circumstances can the 
Imperial Bank issue notes to an amount exceed- 
ing three times the amount of coin held in its 
reserves. 

The only effect of taxation upon bank-note issues 
is to render them expensive and to prevent the 
banks from issuing notes before interest rates have 
become high. But the prevalence of a high rate 
of interest in Wall Street, which probably would 
induce the issue of notes, would afford no test or 

63 



THE BANKING AND CURRENCY PROBLEM 

indication of the probable safety of an issue of 
more notes or of a further expansion of credits. 
At best, a highly taxed issue of bank-notes is a 
so-called " emergency circulation' ' available only 
in times of stress and panic. It is of no avail as 
a means of preventing a money stringency and pos- 
sible panic. It does not furnish a means of in- 
creasing the bank reserves or of restraining the 
banks from unduly expanding credits in times 
when money is easy, so that they may be able to 
reduce their reserves or to expand their credits 
when a period of stringency is threatened. Taxa- 
tion does not add in the least to the security of 
bank-notes or to the ability of the banks to pay 
their depositors and note-holders in lawful money 
on demand. 

The Aldrich-Vreeland Act was passed May 30, 
1908, as a temporary measure of protection against 
severe money stringencies or panics that might 
occur prior to the enactment of a permanent meas- 
ure pursuant to the recommendations of the Na- 
tional Monetary Commission. Therefore, this Act 
should not be criticised as though it were designed 
to be a permanent addition to our currency laws. 
However, it is proper to observe that the Act fur- 
nishes no means of regulating bank credits, and 
that it contains no provisions intended to prevent 
the over-expansions of credit which cause money 

64 



IN THE UNITED STATES 

stringencies and panics. The Act authorizes the 
National banks, under certain conditions, to issue 
additional notes upon payment of a tax upon such 
notes when in circulation, at the rate of 5 per cent, 
per annum for the first month with a monthly in- 
crease at the rate of 1 per cent, per annum for each 
subsequent month until the rate of the tax shall 
have reached 10 per cent, per annum. The Act 
includes no provision for increasing the bank re- 
serves during periods of easy money, nor any in- 
ducements to the banks to hold back part of their 
power to grant credits for use in times of money 
stringency or panic. At best, the Act is a measure 
to mitigate money stringencies and panics after the 
event. 

The apparent purpose of the Act was to enable 
the banks to avoid a depletion of their reserves 
and the resulting violent contraction of their credit 
power when depositors withdraw a large amount 
of lawful money for use as a circulating medium 
or to be hoarded. These, however, are not the 
only conditions under which the banks can issue 
notes under the Act. The banks are enabled to 
issue the notes in case of any severe money strin- 
gency, though resulting from an expansion of cred- 
its beyond the limit of safety. The banks can 
issue the notes whenever the prevailing interest rate 
shall be so high that they can afford to pay the tax 

65 



THE BANKING AND CURRENCY PROBLEM 

imposed by the Act rather than to diminish their 
reserves and curtail their loans. 



Regulation by Government Note Issue 

It has been argued persistently that the issue of 
notes for use as currency, like the coinage of the 
precious metals, is a Governmental function that 
should be exercised exclusively by Government, 
and that it should not be delegated to the banks. 
It also has been urged that financial conditions 
can be regulated adequately through the issue of 
Government notes. The answer to these conten- 
tions is that it is not true that the issue and re- 
demption of Government notes to supply and to 
regulate the currency ever has been considered by 
any nation to be a Governmental function, and 
that it would be wholly impracticable to regulate 
financial conditions by the issue and redemption 
of Government notes. No nation ever has resorted 
to an issue of Government notes, except in times 
of stress and trouble and low national credit, and 
invariably such issues have proved in the end a 
source of trouble and danger. Our own Govern- 
ment notes w r ere issued in war times, and subse- 
quently caused untold financial troubles and losses 
to the people of the United States. At present 
these notes have been rendered innocuous by the 

66 



IN THE UNITED STATES 

limitation of their issue and by the Government's 
pledge to redeem them on demand in gold and to 
maintain a large reserve of gold for that purpose. 
To extend the issue of such notes would be to invite 
a return of the financial evils from which, for more 
than ten years after the war, the country grievously 
suffered. 

How could an issue of Government notes be made 
elastic, so as to contract when contraction is neces- 
sary for the safety of the credit situation of the 
country ? How could an issue of Government notes 
be used as a means of regulating the general credit 
situation? How could it be used, when interest 
rates are very low, as a means of preventing the 
over-expansions of credits which cause subsequent 
money stringencies and panics? The present vol- 
ume of Government notes and National-bank notes 
is excessive in dull times. Is it proposed in dull 
times to redeem and cancel some of the existing 
Government notes and National-bank notes? If 
not, then an issue of more Government notes would 
mean only further expansion. But, even if reg- 
ulation were possible by the issue and redemption 
of Government notes, can any one having the least 
familiarity with actual conditions and with the 
teachings of history believe that it would be safe 
and wise to vest in the Government a discretionary 
power to increase or to diminish the currency of the 

67 



THE BANKING AND CURRENCY PROBLEM 

country, so that the amount of the currency and the 
expansion of bank credits, from time to time, would 
be dependent wholly upon the will of the President 
or of the Secretary of the Treasury ? 

This plan suggests other questions that demand 
consideration. How would the Government put 
its notes out? It could not give them away. 
Either it must suspend the levying of taxes and 
pay its debts by issuing its own promissory notes, 
or it must lend its notes to the banks. On what 
terms and on what security would the Government 
lend its credit to the banks ; and with seven thou- 
sand clamorous National banks, how could this be 
done without favoritism? 

Again, would the Administration be empowered 
to issue notes without limit? If not, how would 
the limit be fixed? 

It is assumed, of course, that the Government 
notes would not be irredeemable fiat money, but 
that they would be payable on demand in gold. 
Then the Government, at all times, would have to 
maintain an adequate reserve of gold, and be pre- 
pared to pay in gold all notes as presented. How 
would the Government obtain the supply of gold 
as needed? 

Does any one believe that it would be wise to 
inject such questions into party politics? In view 
of the financial heresies that sometimes have pre- 

68 



IN THE UNITED STATES 

vailed and still are extant, and in view of our politi- 
cal methods, any plan of issuing additional Govern- 
ment notes in the United States, even under the 
most careful original safeguards, would produce 
endless uncertainty and political agitation, and in- 
evitably would tend to financial disaster. 



The European System of Commercial Credits 

It has been asserted that, in large part, the 
stability and the safety of financial conditions in 
Europe are due to the European system of com- 
mercial credits, and that satisfactory financial con- 
ditions cannot be secured in the United States 
except by the adoption of a similar system. 

In Europe, when a merchant buys goods on 
credit from another merchant, or from a manu- 
facturer, in many cases the seller of the goods 
draws for the price either upon the purchaser, if 
the latter has an established credit, or upon bankers 
with whom the purchaser previously has arranged 
that they shall lend him their credit up to a certain 
amount by accepting bills drawn for the price of 
goods bought in the course of his business. In 
such case the purchaser undertakes to furnish the 
bankers with funds for the payment of their ac- 
ceptances when due, and sometimes the goods and 
their proceeds are pledged as security. Foreign 

69 



THE BANKING AND CURRENCY PROBLEM 

bills commonly are drawn upon bankers, with the 
documents for the goods attached. Such a bill of 
exchange, bearing the name of an undoubtedly 
good acceptor in addition to the name of the 
drawer, can be sold readily to a bank at the cur- 
rent rate of discount, and the drawer of the bill 
is enabled thus to obtain funds if desired prior to 
the maturity of the bill. 

In the United States the practice generally is 
different. When a merchant buys goods on credit 
the seller does not draw upon the purchaser or 
upon bankers for his account, nor does the pur- 
chaser give his note for the price of the goods. 
Usually the seller contents himself with an account 
receivable payable after thirty days or more. The 
seller receives no commercial paper, and if he should 
need funds before maturity of the book account he 
must borrow from the banks upon his paper, with 
or without accommodation indorsement. If, in 
order to obtain the benefit of trade discounts for 
prompt payment, the purchaser should desire to 
pay cash, he would commonly borrow the neces- 
sary funds upon his own note. 

The European system undoubtedly has ad- 
vantages over the American system. The seller 
of goods is safer, because he receives commercial 
paper bearing the name of an acceptor of high 
credit, and this paper can be discounted without 

70 



IN THE UNITED STATES 

difficulty. For the same reason the several banks 
which discount such paper also are safer. Further- 
more, though the European system of commercial 
credits involves the creation of bank credit in the 
same amount as the American system, it is better 
for the general credit situation. This is so because 
commercial paper created under the European 
system is a more salable asset in the hands of the 
banks than the single name or accommodation 
paper created under the American system. The 
several banks can carry smaller reserves in Europe 
than in the United States because, in case of need, 
such commercial paper can be rediscounted readily 
either at their central bank at home or in the large 
commercial centres of Europe. 

There are several reasons, however, why this 
European system of commercial credits is not 
available as a means of preventing the financial dis- 
turbances which often occur in the United States. 
One reason is that this system is not in accordance 
with our business methods and habits, and it is 
not practicable, by legislation, to revolutionize the 
business methods and habits of the people. An- 
other reason is that it is doubtful whether the in- 
troduction of this European system would have a 
far-reaching effect, inasmuch as the legitimate com- 
mercial credits granted by the banks in the United 
States are not the principal source of danger to the 

7i 



THE BANKING AND CURRENCY PROBLEM 

general credit situation. A third reason is that the 
principal advantage of the European system can 
be obtained only after establishing more stable 
financial conditions and more stable interest rates, 
so that the holders of commercial paper may be sure 
of a ready market for such paper at a reasonable 
rate of discount. 

The European system of commercial credits is 
the result, and is not the cause, of stable financial 
conditions. In the United States the first step 
should be to secure reasonable stability of credit 
conditions and of interest rates by providing the 
necessary central regulation. After securing such 
necessary stability, it is probable that the more de- 
sirable credit methods used in foreign countries 
would be adopted in the United States, and New 
York, like London and Berlin, would become a 
market for international commercial credits. 



Guarantee of Bank Deposits 

It has been proposed to tax all the National 
banks ratably, according to their deposits, to pro- 
vide a guarantee fund for the prompt payment of the 
depositors of every broken bank; and it has been 
asserted that the adoption of this plan would give 
to bank depositors such confidence that there would 
be no more runs upon banks and no more financial 

72 



IN THE UNITED STATES 

panics. Although during the last presidential cam- 
paign this plan was made an issue, and was rejected 
by popular vote, its merits should be considered 
without regard to party politics or party feeling. 

Many have been induced to look with favor upon 
this plan to guarantee bank deposits because they 
have been assured that it would protect innocent 
people who have deposited their savings in the 
banks, and that in order to bring about a result so 
beneficent all banks could well afford to pay a small 
tax upon deposits. It should be borne in mind, 
however, that only a small percentage of the so- 
called deposits of the National banks are savings 
deposits or represent any deposit of money. The 
larger part of these so-called deposits represent 
merely exchanges of credits for business purposes 
between the banks and their so-called depositors. 
Such transactions are perfectly honest and proper, 
but it is absurd to assume that these exchanges of 
credit between business men and the banks are so 
highly meritorious that the Federal Government 
should exercise paternal care for their protection by 
establishing a system of compulsory insurance at 
the expense of the banks, and by requiring the 
sound and conservative banks to pay the losses of 
those people who choose to deal with unsound 
and reckless banks. 

The aggregate losses suffered by the depositors of 
6 73 



THE BANKING AND CURRENCY PROBLEM 

failed National banks by reason of the ultimate 
insufficiency of their assets to pay off depositors in 
full have been very small — less than one-twentieth 
of one per cent. They have been infinitesimal com- 
pared with the losses of the people through bad 
debts, fraud, speculation, gambling, indulgence in 
drink, and other causes largely preventable and 
equally deserving of the paternal attention of the 
Government. If, however, it should be deemed of 
paramount importance to establish a system of 
compulsory insurance for the protection of savings 
depositors, the proper course would be to confine 
this system strictly to savings deposits, and to pay 
for the insurance out of the interest which other- 
wise would be paid by the banks to the depositors. 
The first step in that direction would be to au- 
thorize the National banks to establish separate 
savings departments, to be managed under the 
supervision of the Comptroller of the Currency ac- 
cording to the most approved methods of managing 
savings-banks. 

The whole plan for the guarantee of bank de- 
posits is the result of a confusion of ideas and of a 
misconception as to banking processes. Though 
by a guarantee, or insurance fund, it might be 
possible to protect the depositors of failed banks 
against the small ultimate losses that may appear 
upon final winding up of the banks, it would be 

74 



IN THE UNITED STATES 

absolutely impossible to assure such a sufficiency 
of cash reserves that the depositors of every sus- 
pending bank would receive payment promptly on 
demand. 

If the plan be to insure prompt payment of the 
depositors of a bank immediately upon its failure, 
and not merely to make good any ultimate losses of 
depositors upon the final winding up, the amount of 
cash necessary would be simply enormous. The 
money contributed by the banks to the insurance 
fund either would be locked up by the Government, 
or it would be invested in securities, or it would 
be redeposited in the banks. If the money were 
locked up by the Government the effect would be in 
exactly that amount to reduce the bank reserves, 
with the consequent larger reduction of the power 
of the banks to make loans and grant credits. In 
other words, the reserves of the banks and their 
power to grant credits would each be reduced. If 
the money were invested in securities and thus re- 
turned to circulation, the securities could be re- 
converted into cash only by sale, and in that event 
the purchase money would be drawn from the 
banks, thereby again diminishing their reserves 
and their credit power; a result most likely to hap- 
pen at the very time when the banks could least 
afford to diminish their reserves or to contract their 
credits. Finally, if the money contributed to the 

75 



THE BANKING AND CURRENCY PROBLEM 

guarantee fund were to be redeposited in the banks, 
the only change in the situation would be that the 
banks would have exactly the same reserves as 
before, but subject to calls upon their reserves in 
order to pay off the depositors of any banks that 
may fail. At best, therefore, the plan would operate 
as a compulsory pooling of part of the reserves of 
the banks — the reserves of the prudent and sound 
banks to that extent being made subject to calls 
for the payment of depositors in banks that are 
unsound or badly managed. 

What, then, would be the effect of the plan ? In 
good times and with prosperous business the weak- 
er and speculative banks would be encouraged to 
expand their credits and to increase their loans, 
but in times of stringency and threatened trouble 
the strong and conservative banks would be forced 
to contract credits and to refuse accommodation 
to their customers because of the necessity of main- 
taining and building up their reserves to meet de- 
mands for cash to pay off depositors of failing 
banks. In times of money stringency and threat- 
ened trouble the strong banks would be forced to 
be doubly conservative because they would have 
to be prepared to meet unknown demands, the 
amount of which they could not foresee, and against 
which the utmost caution and foresight would not 
protect them. The tendency of the plan, there- 

76 



IN THE UNITED STATES 

fore, would be to cause expansion of bank credits 
when conservatism is desirable, and to cause con- 
traction of bank credits when credit is most needed 
to prevent panic and disaster. 

No guarantee fund, nor any system of insuring 
bank depositors, can possibly furnish a substitute 
for cash reserves. At best the plan would be but 
an illustration of a man trying to lift himself over 
a fence by his own boot-straps. The plan would 
not increase the bank reserves by one dollar, and 
would not in the least strengthen the general bank- 
ing situation. It would weaken the strong banks 
far more than it would strengthen the weak banks. 
It would tie all the banks together, the good and 
the bad, so that in the event of great stress and 
trouble all would be likely to fall together in one 
general ruin. 

The assumption that the proposed guarantee of 
bank deposits would give to depositors such con- 
fidence that there would be no more runs upon 
banks, and therefore no more bank panics, also is 
unfounded. Runs upon banks by small depositors 
who wish to draw out cash for hoarding are not the 
principal causes of bank suspensions. If people 
cease to make new deposits in a bank, or if the 
larger depositors deliver their checks to other 
banks for collection, it may be forced to suspend, 
though there be no visible run of depositors. But 

77 



THE BANKING AND CURRENCY PROBLEM 

what reason is there to assume that the adoption 
of this plan would inspire confidence and prevent 
runs upon banks? As already indicated, the 
adoption of the plan would not in the least increase 
the ability of the banks collectively to pay de- 
positors on demand, or strengthen the general 
situation, and it would result in tying all the banks 
together, so that in times of stress and trouble all 
would have to suspend. The utmost possible of 
accomplishment would be to insure that, upon 
final winding up, the depositors of the unsound 
banks would be paid in full at the expense of the 
sound banks. Would the belief of depositors that 
in case of the failure of their bank they will get 
their money in a year or more, and that in the 
mean time general financial disaster may over- 
whelm the country, be likely to prevent them from 
trying to get their money as soon as possible ? 

But even if it were true that the adoption of this 
plan would make equally safe all deposits in Na- 
tional banks, thereby inspiring confidence in all 
National bank deposits, the plan would prove 
a direct encouragement to " wildcat' ' banking, 
and ultimately would prove disastrous. It would 
enable speculators or inexperienced persons to 
form a bank with small capital, and on the strength 
of this guarantee to obtain large deposits by offer- 
ing to allow rates of interest higher than could be 

78 



IN THE UNITED STATES 

afforded by a conservatively managed bank; and 
then they could use these deposits in promoting 
speculative or unsound ventures. They would risk 
the loss of only the small capital which they con- 
tributed and their individual liability for an equal 
amount. Should their speculations succeed they 
would reap large profits, but if their speculations 
should fail and the money obtained from depositors 
be wasted, the loss would fall upon the sound 
banks. 



State Banks and Trust Companies 

The report of the Comptroller shows that in 
June, 1907, there existed in the United States 
19,746 banks and trust companies, classified as 
follows : 

Number. Capital. Individual Deposits. 

National banks 6,429 $883,700,000 $4,322,900,000 

State banks 9*967 47 I »663,037 3,068,649,860 

Trust companies 794 276,146,081 2,061,623,035 

Savings-banks ^A T 5 34> 22 4>322 3,495,410,087 

Private banks 1,141 25,144,822 151,072,225 

Total 19,746 $1,690,878,262 $13,099,655,207 

In addition, there were numerous non-reporting 
companies and firms doing a banking business, some 
of them receiving large deposits and engaging in 
banking operations on a large scale. 

It has been urged that the failure of one or of a 

79 



THE BANKING AND CURRENCY PROBLEM 

few of the large State banks or trust companies 
may precipitate a general panic involving all the 
banks and trust companies in the country, and that, 
therefore, no sound system of banking and currency 
can be established in the United States unless the 
various State banks and trust companies, as well as 
the National banks, are subjected, by Act of Con- 
gress, to some system of uniform inspection and 
regulation. 

In the opinion of the writer, this view is not well 
founded. The serious financial troubles in the 
United States have not been due to dishonesty or 
bad judgment in the management of individual 
banks or trust companies. They have been due 
to the absence of intelligent central regulation of 
the general credit situation, and to the absence of a 
central power to provide for unexpected demands 
for currency and for unexpected strains upon the 
general banking situation. Without this central 
regulation and control no system of uniform in- 
spection and regulation of the several banks and 
trust companies would render the banking situation 
safe. Undoubtedly the existence of diverse State 
banks, trust companies, and private banking firms 
emphasizes the necessity that some central au- 
thority shall be established with power to regulate 
and to protect the general banking situation; but 
foreign experience shows that where such a central 

80 



IN THE UNITED STATES 

power exists, the individual banks, in great meas- 
ure, can be left to take care of themselves, and 
that close regulation of the individual banks is not 
necessary to insure the safety of the general credit 
situation. In England there are many joint stock 
banks which, though doing an enormous volume of 
business, are subject to very little regulation and 
many private banking firms that are subject to no 
regulation at all. Yet it has been found practicable, 
through the Bank of England, to keep the general 
financial situation sound and safe, and to meet 
extraordinary conditions, like those caused by the 
failure of the great international house of Baring 
Brothers & Co. Similar conditions prevail in 
France and Germany. 

By the establishment of a central agency em- 
powered to regulate the issue and redemption of 
currency by the National banks, the general ex- 
pansion of credits could be regulated and the safety 
of the general banking situation could be insured 
without subjecting the State banks and trust com- 
panies to National regulation. Under such cir- 
cumstances the regulation of the individual affairs 
of the several State banks and trust companies and 
private banking firms would not be a matter of 
National concern. It is believed that the plan 
herewith submitted would furnish a means of reg- 
ulating and protecting banking conditions through- 

81 



THE BANKING AND CURRENCY PROBLEM 

out the country as effective as that existing in 
Germany, and a method much more effective than 
the English system. 

Grave constitutional and practical difficulties 
would embarrass any attempt to regulate the en- 
tire banking business of the United States by Act 
of Congress. The Constitution does not confer upon 
Congress power to regulate the banking business, 
nor does it confer upon Congress power to regulate 
corporations. Therefore, any National legislation for 
the regulation of the banking business, or for the 
regulation of banking corporations organized under 
State laws, could be sustained only so far as such 
regulation should constitute a proper exercise of 
some other power expressly vested in Congress by 
the Constitution. The Act of Congress imposing a 
tax of ioper cent, on State bank-notes was sustained 
by the Supreme Court, partly as an exercise of the 
taxing power of the Federal Government and partly 
as an incident to the power of Congress to coin 
money and to issue bills of credit. Possibly the 
Supreme Court might sustain legislation prohibit- 
ing all banks, except those regulated by Act of 
Congress, from engaging in transactions directly 
connected with interstate commerce, and possibly 
the Supreme Court might even sustain legislation 
affecting the right to use bank checks and drafts 
in interstate commerce, on the ground that such 

82 



IN THE UNITED STATES 

legislation would be an exercise of the power of 
Congress to regulate interstate commerce ; but there 
appears to be no basis for sustaining the con- 
stitutionality of an Act of Congress regulating the 
business of receiving deposits and of making loans 
or discounting paper. 

The proposal indirectly to regulate the banking 
business through the taxing power should not be 
countenanced, for it would evade the spirit of the 
Constitution, even though the courts should feel 
obliged to uphold such legislation because of 
their unwillingness to scrutinize the reasonable- 
ness of a tax or the motive of Congress in impos- 
ing it. 

Though it may be desirable to subject all the 
State banks and trust companies to uniform Na- 
tional regulation, it is to be borne in mind that there 
are also many other subjects which it would be 
desirable to regulate by uniform National legislation, 
but under our system of Constitutionl government 
such legislation is impossible. Any attempt to 
prohibit the banking business under State laws or 
to subject the State banks and trust companies to 
National regulation would involve serious consti- 
tutional and practical difficulties, and in most of 
the States probably would meet with popular dis- 
approval. 

83 



THE BANKING AND CURRENCY PROBLEM 

How Central Regulation can be Secured 

If the views herein expressed are correct, no 
safe and sound system of banking and currency is 
possible without some central agency having power 
to control the expansion of bank credits in the 
aggregate in relation to bank reserves in the aggre- 
gate, and power also to protect the general credit 
situation in case of an unexpected strain upon the 
banks by the withdrawal of large sums from their 
cash reserves. 

In England the necessary central control and 
protection are obtained through the Bank of Eng- 
land by raising or lowering its discount rate. By 
raising its discount rate the bank, to some extent, 
can raise the current interest rate in the London 
market, and thereby can limit the expansion of 
credits and cause gold to flow to England, thus 
increasing the bank reserves. The Bank of Eng- 
land cannot control or protect the credit situation 
by means of note issues. Except as to about 
ninety million dollars of notes issued against Gov- 
ernment securities, the Bank of England cannot 
issue notes without receiving and holding in its 
issue department an equal amount of gold, so that 
the issue and redemption of Bank of England notes 
does not affect the volume of currency in the 
country or the reserves of the bank against de- 

84 



IN THE UNITED STATES 

posit liabilities incurred in its discount depart- 
ment. 

The great prestige and power of the Bank of 
England are based largely upon long-established 
traditions and business habits. In the United 
States no additional legislation would be required 
to establish such a bank, except to constitute it 
the sole depositary of Government moneys. The 
fact that no such bank has been created in the 
United States is some indication that such a bank 
would not be in harmony with our institutions 
and that it could not be established. 

But, even though it were practicable to create 
here a central bank with the prestige and power 
of the Bank of England, the English system would 
not prove adequate in a country as large as the 
United States, or in a country in which the demand 
for bank credits and the demand for currency as 
a circulating medium fluctuate as widely and as 
rapidly as in the United States. Unless the por- 
tion of the country's banking power concentrated 
in the central bank were larger than in England, 
any attempt to regulate bank credits and reserves 
by changing the discount rate of the central bank 
would prove ineffective and certainly would be too 
slow. Even in England the English system, prob- 
ably, would not have proved workable if England 
were not largely a creditor nation and London a 

85 



THE BANKING AND CURRENCY PROBLEM 

clearing-house for commercial credits throughout 
the entire world. A change in the discount rate 
of the Bank of England has an immediate and 
marked effect upon the entire volume of inter- 
national drafts drawn upon the English banks. 
Even in England this system has not always proven 
adequate, as is shown by the fact that on several 
occasions it became necessary to suspend the Bank 
Act and to authorize the Bank of England to issue 
its notes without adding a corresponding amount of 
gold to the reserve in its issue department, and on 
several occasions the Bank of England found it 
necessary to obtain assistance by borrowing gold 
from the Bank of France. 

The most effective and the most rapid means of 
regulating and protecting the general credit situa- 
tion is by increasing or diminishing the volume of 
outstanding bank-note currency not covered by 
a reserve of gold or other lawful money. This 
method is that used successfully both in France 
and in Germany. The Bank of France and the 
Imperial Bank of Germany to some extent regulate 
credit conditions by acting as central banks of dis- 
count ; but their most effective action is by increas- 
ing or diminishing the uncovered amount of their 
outstanding notes. When additional currency is 
needed as a circulating medium they supply this 
currency by issuing notes. When contraction of 

86 



IN THE UNITED STATES 

the currency, or a check upon the further expansion 
of bank credits, is desirable, they accomplish the 
result by diminishing the volume of their outstand- 
ing notes and by raising the discount rate. 



Plan for Central Regulation in the United States 

The problem, then, is to establish some central 
agency having power to control the volume of un- 
covered bank-note currency in the United States 
without creating a central bank vested with a 
monopoly of the power to issue bank-notes and able 
to dominate all the banks in the country. 

In substance, the plan now submitted is to au- 
thorize the National banks to issue notes upon 
their joint credit and to control the uncovered 
amount of these notes by the joint action of the 
Secretary of the Treasury and of a managing board, 
or committee, elected by the banks. 

To carry out this plan, an Act of Congress should 
be passed authorizing the National banks to form 
an association, subject to terms and conditions 
prescribed in the Act, for the sole purpose of issuing 
notes upon their joint credit. The association 
should have no capital and should not have power 
to receive deposits. It should be simply a joint 
agency of the associated banks, like a large clearing- 
house association. The association should become 

87 



THE BANKING AND CURRENCY PROBLEM 

operative when banks having a fixed aggregate 
capital stock of not less than two hundred and fifty 
million dollars shall have become members, but all 
National banks should be entitled at any time to 
join the association. 

The banks constituting the association should 
elect a managing board, or committee, consisting 
of fifteen to twenty-one experienced bankers or 
business men familiar with general conditions and 
with financial operations, and this managing board 
should control the affairs of the association. How- 
ever, as the entire community is interested in the 
character of the currency and in the stability of 
financial conditions and of interest rates, no action 
of the managing board affecting the volume of out- 
standing notes, or the percentage of the redemption 
fund for the payment of the notes, should be effec- 
tive until approved by the Government through the 
Secretary of the Treasury. The Comptroller of the 
Currency should be, ex officio, a member of the 
managing board of the association. 

The elected managers of the association should 
hold office for three years, and should be classified 
so that one-third shall be elected annually. Each 
bank should have one vote for each $25,000 of its 
capital stock for each manager to be elected and 
should have power to cumulate its votes. To fix 
the votes of the several banks according to their 



IN THE UNITED STATES 

capital stock would be fair and would prevent any- 
particular class of banks from controlling the 
association, as is shown by the following figures 
taken from the report of the Comptroller for 1907: 

Number of Aggregate 

Ca P ltal * Banks. Capital. 

Less than $50,000 2,063 $54,322,000 

$50,000 and not over $250,000 3>3°4 232,250,920 

Over $100,000 but not over $250,000. . . . 741 135,379,585 

Over $250,000 but not over $1,000,000. . . 472 250,026,920 

Over $1,000,000 but not over $5,000,000. . 64 139,080,700 

Over $5,000,000 6 84,000,000 

Aggregate of all kinds 6,650 $895,060, 125 



Branches and Agencies 

The principal office of the association should be 
in Washington, and the association should be re- 
quired to establish a branch or agency for the 
issue and redemption of notes in each city in which 
there is a United States sub-treasury. The associa- 
tion should be permitted to establish branches and 
agencies wherever the board of managers may deem 
advisable, either for the issue and redemption of 
notes or only for the redemption of notes. It 
should be the duty of the association, within two 
years after it has commenced operations, to es- 
tablish a branch or agency for the redemption of 
notes in every city of the United States having a 
population of one hundred thousand persons. 
7 89 



THE BANKING AND CURRENCY PROBLEM 

Meetings of the Board of Managers, etc* 

The managers of the association should hold 
their meetings at the principal office in Washing- 
ton, or at other places approved by the Comptroller 
of the Currency. Regular meetings of the board 
should be held monthly, and there should be an 
executive committee of three residing in Washing- 
ton and holding daily meetings. The executive 
committee, upon receiving the approval in writing, 
or by telegraph, of a majority of all the members 
of the board, should have power to act for the 
whole board upon any proposal to increase or to 
diminish either the authorized volume of notes or 
the percentage of the redemption fund. 

The board of managers should have power to ap- 
point such committees, officers, and agents as they 
may deem advisable for the management of the 
association and its several branches and agencies. 



Limit of Note Issues under Plan 

Each bank, being a member of the association, 
should have a right to take out and to issue notes 
up to an amount which, including its present bond- 
secured notes, shall not exceed its capital stock. 
With the approval of the Secretary of the Treasury, 
the managing board should have the power from 
time to time to increase, ratably as to all banks, the 

90 



IN THE UNITED STATES 

authorized amount of their note issues, and there- 
after to reduce any such increase that may have 
been authorized; but this power to increase the 
authorized amount of the note issues should be 
limited to some fixed percentage of the capital stock 
of the banks. No bank should be authorized to 
take out notes unless its capital stock be wholly 
paid up and unimpaired, nor if it be in de- 
fault in depositing and keeping up its note -re- 
demption fund or in the payment of any sum due 
to the association. The notes should be prepared 
by the association, under the supervision of the 
Comptroller of the Currency, and every act of the 
association should be subject to the supervision of 
the Comptroller. 



Redemption Funds under the Plan 

Each bank having taken out notes should be re- 
quired to keep on deposit with the association, as a 
redemption fund for their payment, a sum of lawful 
money equal to 20 per cent, of such notes, or such 
greater per cent, thereof as from time to time may 
be prescribed by the board of managers and the 
Secretary of the Treasury. The note redemption 
funds of the several banks should be administered 
by the board of managers, under the supervision of 
the Comptroller of the Currency. 

91 



THE BANKING AND CURRENCY PROBLEM 

Upon taking out notes, each bank would be re- 
quired to deposit in its note-redemption fund the 
prescribed sum of lawful money. Whenever, be- 
cause of the payment of notes of a bank out of its 
redemption fund, or because of an increase of the 
prescribed percentage of the redemption funds, the 
redemption fund of any bank shall fall below the 
percentage then prescribed by the board of mana- 
gers and the Secretary of the Treasury, the bank, 
upon call of the board of managers, should be re- 
quired to deposit such sum as may be necessary to 
make up the deficiency. However, in order to avoid 
needless multiplicity of calls upon the banks, the 
board of managers should not be obliged to call upon 
a bank to make up a deficiency amounting to less 
than 3 per cent, of the outstanding notes of the bank. 

The great function of the board of managers, in 
conjunction with the Secretary of the Treasury, 
would be, from time to time, to fix the authorized 
limit of the note issues of the several banks (if any 
increase beyond their capital stocks be authorized) 
and to fix the amount of lawful money to be de- 
posited with the association for the redemption of 
the notes. 

This power of the board of managers, in con- 
junction with the Secretary of the Treasury, to in- 
crease or to diminish the percentage of the note- 
redemption funds, would enable them to regulate the 

92 



IN THE UNITED STATES 

uncovered volume of the notes outstanding and to 
give stability to financial conditions generally. It 
is here to be borne in mind that it is not the nominal 
amount of outstanding bank-notes that counts, but 
only the portion of the notes that is not covered 
by a redemption fund or reserve of legal -tender 
money. The issue of $1,200,000,000 of bank-notes 
against a reserve of 50 per cent, (or $600,000,000) 
has no greater effect in expanding the currency and 
the credit power of the banks than the issue of 
$631,578,947 of bank-notes with a redemption fund 
or reserve of 5 per cent. In each case the net in- 
crease of the currency would be $600,000,000, that 
being the amount of notes not covered by the re- 
demption fund or reserve of lawful money. 

However, there are advantages in using a large 
note issue with a large percentage of reserve rather 
than a small note issue with a small percentage of 
reserve, partly because the use of bank-notes is 
more convenient than the use of gold and saves 
loss by abrasion, and partly because the use of 
notes covered by a large reserve renders it com- 
paratively easy to expand the currency in case of 
a sudden demand by reason of a panic or other 
cause. Thus, with a reserve of $600,000,000 
against outstanding notes amounting to $1,200,- 
000,000, it would be practicable, in case of need, 
to empower the banks to issue $600,000,000 of 

93 



THE BANKING AND CURRENCY PROBLEM 

additional notes against this reserve by reducing 
from 50 to 33 J per cent, the required percentage 
of the reserve, whereas no such increase could be 
brought about with safety if there existed only a 
reserve of $31,578,947 against $631,578,947 of notes 
already outstanding. 



Separate Reserves for the Notes 

Under the present system in the United States 
the only special reserve for the outstanding Na- 
tional-bank notes is the 5 per-cent. redemption fund 
deposited with the Government, and this 5 -per-cent. 
redemption fund is counted also as part of the 
minimum reserves of the banks against deposit 
liabilities. In fact, each bank's general reserve 
against deposit liabilities, together with any money 
in its 5-per-cent. note-redemption fund, constitutes 
the bank's reserves for the payment of its notes as 
well as its deposit liabilities, but the 5-per-cent. 
redemption fund deposited with the Government 
is not available as a reserve for the deposit lia- 
bilities until the notes shall have been paid. 

For several reasons this system is bad. A re- 
serve of 5 per cent, would be utterly inadequate for 
an elastic issue of bank-notes — that is to say, an 
issue that can be contracted as well as expand- 
ed and that can be regulated according to the 

94 



IN THE UNITED STATES 

requirements of the general financial situation. 
Under the present system the 5-per-cent. redemp- 
tion fund has proved adequate only because the 
volume of the outstanding bank-notes is not elastic 
and does not fluctuate rapidly, but constitutes 
what has been described as a "sodden mass" 
added to the currency of the country. If, how- 
ever, the general reserves of the banks, together 
with the redemption funds, be considered as re- 
serves for the outstanding notes and the deposit 
liabilities combined, the present system in the 
United States is bad, because it establishes no 
relation between the reserves of the banks and 
their outstanding note issues. Under such a 
system no intelligent regulation is practicable. 

As has been observed, the amount of the reserve 
that should be held by each individual bank, with- 
out considering the general credit situation, de- 
pends upon the nature of the deposit liabilities 
and assets of the particular bank, and upon its 
entire business. A ratio of reserve to deposit lia- 
bilities that would be adequate for one bank 
might be wholly inadequate for another. It 
would be utterly impracticable by any central 
authority intelligently to fix and regulate the re- 
serve which should be kept by each of the seven 
thousand individual banks. The percentage of the 
reserve of each individual bank in relation to its 

95 



THE BANKING AND CURRENCY PROBLEM 

deposit liabilities can be regulated intelligently 
only by the managers of the bank. To regulate the 
general credit situation from time to time, by in- 
creasing or by diminishing the minimum reserve 
requirements of all the banks in relation to their 
deposit liabilities, would involve the application to 
all the banks of a uniform rule upon a subject 
which ought not to be governed by a uniform 
rule. Furthermore, it would be quite impossible 
to enforce an order from a central authority 
directing seven thousand banks to increase the 
percentage of their reserves by reducing their 
loans, their discounts, and their deposit liabil- 
ities. 

The better plan would be to keep separate the 
reserves for outstanding bank-notes and the re- 
serves for deposit liabilities, and, without attempt- 
ing to change and to regulate the reserves for 
deposit liabilities, to regulate the currency and the 
general financial situation by increasing or by 
diminishing the volume of oustanding bank-notes 
and the percentage of reserve for the notes. The 
percentage of reserve for bank-notes ordinarily 
should be larger than the percentage of reserve for 
deposit liabilities, especially if the bank-note issue 
is elastic and serves its true purpose by contracting 
and expanding according to financial conditions. 
There is no reason why all the banks should not 

96 



IN THE UNITED STATES 

be required to keep a uniform percentage of reserve 
for their outstanding notes. 

Of course, in the case of a central bank there is 
no reason for separating its reserve for notes from 
its reserve for deposit liabilities, because the man- 
agement of the central bank is in a position to de- 
termine how much money should be held as a 
reserve for the outstanding notes and how much as 
a reserve for the deposit liabilities. Accordingly, 
the Bank of France and the Imperial Bank of Ger- 
many do not separate the reserve for notes from 
the reserve for deposit liabilities. The Bank of 
France, with a large note issue and small deposit 
liabilities, keeps on hand a reserve of about 80 per 
cent, of its combined notes and deposit liabilities. 
The Imperial Bank keeps a reserve of about 40 per 
cent, of its combined notes and deposit liabilities, 
but it is required to keep in its reserve an amount 
of coin equal to at least 3 3 J per cent, of its note 
issues. The Bank of England, on the other hand, 
keeps its note-issue department entirely distinct 
from its general banking department, and keeps a 
separate reserve for its deposit liabilities. 



Operation of the Plan Illustrated 

The operation of the plan may be illustrated as 
follows: Let us assume that the association of 

97 



THE BANKING AND CURRENCY PROBLEM 

banks has been formed and that all arrangements 
have been made to commence the issue of notes, 
the initial percentage of the note-redemption fund 
having been fixed at 40 per cent. A demand arises 
for the use of additional currency as a circulating 
medium to move the crops, or for other cause, and 
depositors commence to draw lawful money from 
the bank reserves, thereby compelling the banks 
to reduce their loans and discounts and to raise in- 
terest rates. By taking out and issuing notes the 
banks can prevent the depletion of their reserves 
and the necessity of largely contracting their loans 
and discounts, because for every $4,000 of gold or 
other lawful money which they deposit in the note- 
redemption fund they can issue $10,000 in notes. 

If the banks should put in circulation notes to 
the aggregate amount of $300,000,000 against a 
deposit in the redemption funds of 40 per cent, (or 
$120,000,000) of gold or other lawful money, the 
currency in circulation among the people would be 
increased $300,000,000 while the general bank re- 
serves would be reduced only $120,000,000 by 
transferring that amount to the note-redemption 
funds. If the notes had not been issued the banks 
would have been obliged to pay $300,000,000 out 
of their lawful money reserves, but by issuing the 
notes they have been enabled to avoid paying out 
more than $120,000,000. Thus they have saved 

98 



IN THE UNITED STATES 

$180,000,00 of reserve money and have prevented 
a reduction of their credit power to the extent of 
about $1,000,000,000, on the basis of the average 
relation between the deposit liabilities and the re- 
serves of the National banks, or about $2,000,- 
000,000 on the basis of the average of all the banks 
and trust companies of the country. 

Assume then, that, in consequence of a diminu- 
tion of business activity, $200,000,000 of the 
$300,000,000 of additional currency thus put in 
circulation no longer is needed. Thereupon sur- 
plus currency, amounting to $200,000,000, would 
be deposited in the banks ; but, the notes being at 
a parity with gold and other lawful money, people 
would not pick out the notes and deposit the whole 
$200,000,000 in notes, but would deposit notes and 
lawful money indiscriminately. If half of the 
$200,000,000 of surplus currency so deposited were 
to consist of bank-notes and the other half of law- 
ful money, and if thereupon the banks should pre- 
sent the $100,000,000 of notes for redemption in 
lawful money, then from time to time, as the notes 
come in for redemption, the board of managers of 
the association would call upon the banks having 
outstanding notes to contribute to their redemption 
funds $60,000,000 additional gold or other lawful 
money, the other $40,000,000 required to redeem 
the $100,000,000 of notes having been deposited for 

99 



THE BANKING AND CURRENCY PROBLEM 

that purpose in the redemption funds at the time 
of issuing the notes. Upon redemption of the 
$100,000,000 of notes there would remain still out- 
standing $200,000,000 of notes, and there would be 
in the redemption fund 40 per cent, of that amount, 
or $80,000,000 of lawful money. The general re- 
serves of the banks would have been increased 
$100,000,000 by the deposit of that much lawful 
money. 

Increasing bank reserves accompanied by a very 
low rate of interest and a fall in the cost of for- 
eign exchange, and possibly by exports of gold, 
would indicate to the board of managers and 
to the Secretary of the Treasury the need of a 
further reduction of the increase of the currency 
caused by the notes remaining in circulation. In 
that event the board of managers, in conjunction 
with the Secretary of the Treasury, gradually 
would increase the percentage of the note-redemp- 
tion fund from 40 per cent, to, say, 60 per cent. 
This would require the banks having outstanding 
notes to take from their general reserves and to 
deposit in their note-redemption funds $40,000,00. 
of additional lawful money, being 20 per cent, of the 
$200,000,000 of notes remaining outstanding. The 
effect would be the same as though the banks had 
redeemed and cancelled $40,000,000 of the notes by 
paying them in lawful money out of their reserves. 

100 



IN THE UNITED STATES 

The note-redemption fund then would be $120,- 
000,000 against $200,000,000 of outstanding notes 
and the net increase of the currency would be 
$80,000,000. If, thereupon, a substantial fall in 
the percentage of the general reserves of the banks 
and a rise of interest rates and of the cost of foreign 
exchange should indicate an increase in the de- 
mand for currency as a circulating medium, or in 
the demand for bank credits, and if there should be 
no signs of financial disturbances indicating the 
need of a restrictive policy, the managing board and 
the Secretary of the Treasury gradually would re- 
duce the required percentage of the note-redemp- 
tion funds from 60 per cent, to, say, 40 per cent. 
The banks then could withdraw in whole or in part 
the $40,000,000 of surplus in the note redemption 
funds, thereby again adding that amount to their 
general reserves, or they could issue additional 
notes against this surplus. The $40,000,000 of 
surplus in the note - redemption funds after such 
reduction of the required percentage, would be the 
basis (at 40 per cent.) for the issue of $100,000,000 
of additional notes, or, if withdrawn by the banks 
and added to their general reserves, would be the 
basis for about two hundred and fifty million 
dollars of additional bank credits, according to 
the average of the National banks alone, or 
about five hundred million dollars, according to 

101 



THE BANKING AND CURRENCY PROBLEM 

the average of all the banks and trust compa- 
nies. 

Of course, except in case of a panic, the man- 
aging board would not reduce the percentage of 
the redemption funds to the lowest possible point. 
In normal times they would always keep the per- 
centage of the redemption funds sufficiently high 
to furnish a basis for the issue of a substantial 
amount of additional notes to meet the necessities 
of a panic or of any other extraordinary contin- 
gency. The safest situation would be when there 
is a considerable note issue with a very high per- 
centage of reserve, as in France. Though the Bank 
of France has a considerable volume of notes out- 
standing, usually it holds a reserve equal to about 
80 per cent, of its combined liabilities for deposits 
and outstanding notes. 



Uniform or Separate Note Issues of the Banks 

The proposed plan can be worked out either by 
providing for separate note issues of the several 
banks, each bank being required to keep up its 
separate note-redemption fund, or by providing for 
one uniform issue of notes to be executed by the 
association, with a joint redemption fund to be kept 
up by pro rata contributions of the several banks. 

Under the plan for separate note issues, the notes, 

102 



IN THE UNITED STATES 

having been prepared and registered by the associa- 
tion, would be delivered to the banks, which then 
would execute and issue them, as in case of the 
present bond-secured notes. Under this plan each 
bank would be required to furnish to the association 
and to keep up, at the prescribed percentage, its 
separate redemption fund for its own notes. Upon 
presentation of the notes of any bank for redemption 
they would be paid out of the redemption of that 
particular bank. 

Under the plan for a uniform issue of notes with 
a joint redemption fund, the notes would be all 
alike, and would be executed by the officers of the 
association and be delivered to the banks upon 
their application. Under this plan all the banks 
would be required to provide pro rata for the re- 
demption of all notes that are presented for pay- 
ment and would be credited pro rata with all redemp- 
tions. The association would keep with each bank 
a note account and a redemption-fund account. 
Upon taking out notes a bank would be charged 
therewith in its note account, and it would be 
credited in its redemption-fund account with its 
contribution to the fund, such contribution being 
determined by the percentage at which the fund 
then stands. At the close of each business day 
the several banks would be credited in their note 
accounts, in respect of all notes redeemed on that 

103 



THE BANKING AND CURRENCY PROBLEM 

day, pro rata according to the several amounts for 
which they stand indebted on that day in their 
several note accounts; and they would be charged 
in their several redemption-fund accounts with pro 
rata shares of the money paid out of the joint fund 
in redemption of these notes. Upon any call for 
additional contributions to the joint redemption 
fund the pro rata contributions of the several banks 
would be fixed in similar manner. 

Under either plan a bank could discharge its 
obligation in respect of all or any of the notes for 
which it is responsible, either by depositing law- 
ful money for the redemption of the notes or by 
surrendering notes for cancellation. Under the 
plan for separate note issues, a bank surrendering 
all or any of its own notes for cancellation could 
withdraw its note - redemption fund or a ratable 
part thereof. Under the plan for a uniform issue 
of notes, a bank surrendering any outstanding 
notes could withdraw a proportionate share out of 
the joint redemption fund. After having sur- 
rendered for cancellation the whole amount of 
notes for which it stands indebted to the asso- 
ciation, a bank, like any other noteholder, 
could present notes for payment and redemp- 
tion. 

Under either plan, from time to time a bank 
could take out additional notes, as the amount of 

104 



IN THE UNITED STATES 

notes for which it is indebted to the association is 
reduced by redemptions or by the surrender of 
notes, but the amount of notes for which, at any 
one time, a bank may be indebted would be limited 
as provided in the statute. 

The only material difference between the two 
plans is that, in case of separate note issues with 
separate redemption funds, each bank would have 
to provide for the redemption of its own notes 
whenever they come in for redemption, while under 
the plan for a uniform note issue with a joint re- 
demption fund every redemption of notes would 
be treated as a redemption of only a pro rata part 
of the notes for which each bank is chargeable. 
The ultimate responsibility of the several banks 
would be the same under both plans. 

The plan for a uniform note issue with a joint 
redemption fund probably would be simpler, less 
expensive, and easier to administer than the plan 
for separate note issues and separate redemption 
funds; but it would require careful consideration 
by experienced bankers whether the plan for a 
uniform note issue and a joint redemption fund 
would prove fair to all the banks. On the one 
hand, it may be said that it would be largely a 
matter of accident whether the notes issued by a 
particular bank remain in circulation a long time 
or a short time, and, therefore, that it would be fair 
8 105 



THE BANKING AND CURRENCY PROBLEM 

to all the banks to apply all redemptions of notes 
pro rata according to the amount of notes put in 
circulation by each bank. On the other hand, it 
would be necessary to guard against the possibility 
of a bank increasing its general reserves of lawful 
money by presenting notes for payment out of the 
joint redemption fund while the bank remains in- 
debted to the association for outstanding notes. 
For example, if a bank could take out notes, and, 
directly or indirectly, could cause these notes to 
be presented, in its behalf, for payment out of the 
joint fund, it might thus increase its general reserves 
by drawing lawful money from the joint redemp- 
tion fund to which all the banks would have to 
contribute ratably. However, the advantage would 
be only temporary, inasmuch as the bank taking 
out notes and causing them to be redeemed would 
receive credit only for the redemption of its pro 
rata share of these notes. It would still remain 
liable for the balance, less only the part thereof 
represented by its contributions of lawful money 
to the joint redemption fund, and it would have to 
make future contributions to the joint redemption 
fund until it shall have extinguished the whole 
of this liability either by contributions of law- 
ful money or by surrendering notes for cancella- 
tion. 



106 



IN THE UNITED STATES 

Security of the Notes 

It is a matter of primary importance that an 
issue of bank-notes shall be absolutely good and be 
kept at a parity with lawful money; in other words, 
that the notes will be redeemed certainly in gold 
or other lawful money whenever presented for pay- 
ment. While bank depositors generally can look 
out for their own interests and may voluntarily take 
the risks of unwise management of the institutions 
with which they deal, bank-notes would fail to 
serve their purpose as a circulating medium if it 
were necessary in each instance to scrutinize the 
solvency of the banks issuing them. Bank-notes 
that fluctuate in value or that may prove worthless, 
as in the days of our " wildcat banks," would cause 
loss to innocent people throughout the country, 
and would be fatal to business prosperity generally. 
Therefore, clearly, it is the duty of the Government 
to prevent the issue of bank-notes for use as cur- 
rency unless the payment of such notes on demand 
be assured beyond a doubt. 

One of the most dangerous fallacies in banking 
is the idea that a deposit of ample security in the 
form of bonds or anything else is sufficient to make 
an issue of bank-notes sound and safe. It is all im- 
portant that bank-notes shall be convertible on de- 
mand into lawful money. An issue of bank-notes 

107 



THE BANKING AND CURRENCY PROBLEM 

is unsound and unsafe and will fail to serve its pur- 
pose, unless the holders of the notes, at all times, 
can count with certainty upon obtaining gold or 
other lawful money for the notes on demand. It 
is quite as important that the banks should keep 
reserves of lawful money for the payment of their 
notes as for the payment of their deposit liabilities ; 
and if an issue of bank-notes is really an elastic one, 
so that it will contract promptly with the cessation 
of the need for notes, prudence requires that the 
reserves of lawful money kept for the notes shall be 
larger than the reserves for deposit liabilities. It 
is to be observed, also, that the position of all the 
banks collectively would not be strengthened by 
providing collateral security for bank-note issues 
even though the security were to consist of Govern- 
ment bonds for which there is a ready market. A 
purchaser of the bonds would have to draw from 
some bank the money to pay the purchase price. 
The money realized by selling the bonds of the bank 
in default would be obtained by reducing the reserve 
of some other bank. 

Under the plan now proposed the security for 
the payment of the notes on demand in lawful 
money would be as follows : 

(a) A redemption fund, consisting of gold or 
other lawful money, amounting to a substantial 
percentage of the notes; 

1 08 



IN THE UNITED STATES 

(&) The individual obligation of each bank to 
redeem the amount of notes issued by it and to 
keep up its redemption fund for that purpose ; 

(c) A safety fund to be created, as hereinafter 
explained, by a tax to be paid by each bank on the 
amount of notes it has outstanding in excess of the 
lawful money in its note-redemption fund; 

(d) A deposit of United States bonds by those 
banks choosing to deposit bonds as security for 
such excess, in order to obtain the benefit of the 
lower tax upon notes so secured; and 

(e) The ultimate ratable liability of all the issuing 
banks. 

The notes issued under this plan would be safer 
than any bank-notes in the world, except possibly 
the notes of the Bank of England. If, to increase 
popular confidence in the notes, it should be deemed 
advisable that they be guaranteed by the United 
States, there is no reason why the United States 
should not practically guarantee their payment and 
make them receivable in payment of taxes and 
excises and other dues to the United States, as in 
case of the present bond-secured notes. The issue 
of the notes would be supervised and controlled by 
the Government. A guarantee of their payment 
would subject the United States to less risk than the 
present bond-secured notes, because under the pro- 
posed plan the notes would be backed by adequate 

109 



THE BANKING AND CURRENCY PROBLEM 

redemption funds of lawful money, which all the 
banks would be bound to keep up at all times by- 
importations of gold if necessary. Under the 
present system the Government is bound to pay 
the notes of the banks on demand in gold or other 
lawful money. If the Government should not have 
in the Treasury the required amount of gold or 
other lawful money, and if the banks should fail 
promptly to reimburse the Government for the 
payment of their notes, the Government would 
have to sell bonds or borrow the required amount of 
gold. The United States bonds deposited as 
collateral for the bond-secured notes would cease 
to afford adequate security if the artificial value of 
these bonds should be impaired by the issue of 
additional Government bonds, as might happen in 
case of a war. The present artificial value of these 
bonds is caused only by their limited supply and by 
the demand of the banks for such bonds as a basis 
for the issue of bond-secured notes. 



Collateral Security 

Collateral security would not be needed to pro- 
tect the associated banks against loss by reason of 
defaults of individual banks in keeping up their 
note-redemption funds, because the experience of 
forty years proves that the losses through failures of 

no 



IN THE UNITED STATES 

individual banks would be infinitesimally small and 
that the safety fund would be many times more 
than sufficient to cover any losses. 

Collateral security, no matter how good, is in no 
sense a substitute for gold or lawful money as a 
reserve for the payment of bank-notes which, on 
demand, must be paid in cash. Collateral would be 
security only for the ultimate payment of the notes 
and, for the reasons already stated, is unnecessary 
for that purpose. 

It would not be practicable to furnish security in 
the form of commercial paper, because a central 
agency could not pass intelligently upon the charac- 
ter of such paper, or satisfactorily administer collat- 
erals consisting of commercial paper maturing from 
day to day. It would not be practicable, through 
a central agency, to collect the maturing paper and, 
in case of non-payment, to notify indorsers and en- 
force payment or arrange for extensions, etc. It 
would be inadvisable to make municipal bonds or 
bonds of private corporations receivable as collat- 
eral, partly because of the complications which 
would ensue if any board were vested with a dis- 
cretionary power to pass upon such securities, and 
partly, also, because an artificial value would be 
given to such securities by making them receivable 
as collateral for bank-notes. The right to issue 
the present bond-secured notes against United 

in 



THE BANKING AND CURRENCY PROBLEM 

States bonds has given to these bonds an artificial 
value, probably at least 20 per cent, in excess of 
their real value as investments, and consequently 
the holders of United States bonds, including the 
banks, consider now that this artificial value is a 
vested right that should be protected by law. If 
municipal bonds or other bonds were made re- 
ceivable as collateral security for bank-note issues, 
these bonds, likewise, soon would acquire an ar- 
tificial value, and it would be claimed that, in 
justice, this artificial value should not be im- 
paired by any subsequent change of the currency 
laws. 

However, though it is undesirable and unwise 
to require collateral security for an issue of bank- 
notes, some of the objections that have been raised 
against collateral security for bank-notes appear 
to be unfounded. Thus it often has been contended 
that the present issue of bond-secured National- 
bank notes is inelastic because United States bonds 
must be deposited as security for such notes. This 
appears to be a mistake. The true reason why 
the issue of these bond-secured notes is inelastic is 
that each one of the seven thousand banks at all 
times issues and keeps outstanding all the notes 
it can, guided only by the desire to make a profit 
for itself and regardless of the credit situation of 
the whole country. An issue of notes simply upon 

112 



IN THE UNITED STATES 

the credit of the banks, without collateral security, 
would be equally inelastic unless regulated and con- 
trolled through some central authority by increas- 
ing or diminishing the required reserve for the 
notes. 

Again, it has been contended that if the banks 
deposit bonds as collateral security for their notes, 
they must use part of their capital in paying the 
purchase price of the bonds, and that this would 
diminish the amount of capital or credit of the banks 
available for the accommodation of the commercial 
business of the country. This appears also to be 
a mistake. When a bank invests in bonds to be 
used as collateral for notes of the bank the money 
paid for the bonds is not locked up or taken out of 
circulation, but remains in the country, and re- 
mains available as circulating currency and as 
bank reserves. The only lawful money that may 
be locked up under the present laws is the 5 per 
cent, of the notes to be deposited in lawful money 
with the Government, and even that money is not 
necessarily locked up, as the law requires it to 
be turned into the Treasury as a miscellaneous re- 
ceipt. On the other other hand, there is an actual 
increase of the circulating currency by the amount 
of the notes. To the extent that these notes are 
used as a circulating medium, they save the use 
of that much lawful money, which goes into the 

113 



THE BANKING AND CURRENCY PROBLEM 

bank reserves and becomes available as a basis for 
granting additional bank credits. 

Protection of United States Bond Values 

There has developed a sentiment that any cur- 
rency legislation that may be passed should con- 
tain such provisions as will preserve the artificial 
value heretofore given to Uinted States bonds by 
making them available as security for the issue of 
National - bank notes. In order to protect this 
artificial value of United States bonds it should be 
provided that any bank issuing notes under the 
plan now proposed shall have the privilege of de- 
positing United States bonds as collateral security 
for the uncovered part of the notes, and that in 
consideration of furnishing such security (which 
would protect the safety fund and the other banks 
from ultimate loss) the banks making such deposit 
of United States bonds shall pay only the present 
taxes upon their circulation so secured, and shall 
be relieved from the higher taxes to be imposed 
upon notes issued without such collateral security. 

Taxation of Notes under the Plan 

In fixing the rate of the tax to be imposed upon 
the proposed circulation, the following considera- 
tions should be borne in mind : 

114 



IN THE UNITED STATES 

(a) Bank credits and bank-notes are merely part 
of the machinery for transacting business, and this 
machinery should not be made unnecessarily ex- 
pensive to the people, by taxation or by other 
artificial means. Ultimately a high tax upon 
bank credits or currency would fall upon bor- 
rowers and would operate as a check upon busi- 
ness generally. 

(b) A tax upon bank-notes or bank credits is 
not required to obtain revenue for the Govern- 
ment. 

(c) Taxation is neither a scientific nor an effect- 
ive method of regulating bank credits or of 
keeping the banks sound and the currency safe. 
The right way to prevent an issue of bank-notes 
from causing an unsafe expansion of bank cred- 
its is by requiring the banks to increase the re- 
serve for the redemption of the notes, thereby 
diminishing the amount of notes outstanding in 
excess of this reserve. If it be desirable to re- 
duce the profits derived by the banks from their 
note issues, the proper way to accomplish this is 
to compel the banks to reduce the uncovered 
amount of the notes by increasing the redemption 
fund or reserve for their payment. Though taxa- 
tion of bank-notes may restrict the issue of bank- 
notes, it cannot add to their security or strengthen 
the situation of the banks. 

115 



THE BANKING AND CURRENCY PROBLEM 

(d) A small tax upon bank-notes for the purpose 
of providing a safety fund for the payment of the 
notes of defaulting banks is proper, and, as shown 
by present experience in Canada and by former ex- 
perience in New York, such a safety fund would 
accomplish its purpose. 

(e) A tax upon bank-notes should be based upon 
the portion of the notes not covered by gold or other 
lawful money in the note - redemption fund. It 
should not be based upon the nominal amount of the 
notes outstanding, for a considerable issue of notes 
with a large percentage of gold or other lawful 
money in the redemption fund is better and safer 
than a small issue of notes with a smaller percentage 
of reserve. It is only the uncovered part of a note 
issue that represents an increase of the currency 
based upon the credit of the banks. 

Having regard to these considerations, it is pro- 
posed that each bank be required to pay quarterly 
a tax computed at the following rates on the aver- 
age amount of notes it has outstanding in excess of 
the average amount of gold or other lawful money 
in its note-redemption fund — viz. : 

(i) At the rate of one-half per cent, per annum 
on so much of such excess as is secured by a de- 
posit of United States 2-per-cent. bonds. 

(2) At the rate of 1 per cent, per annum on so 
much of such excess as is secured by United States 

116 



IN THE UNITED STATES 

bonds bearing interest at a rate greater than 2 per 
cent. 

(3) At the rate of 3 per cent, per annum on any 
remainder of such excess. 

These taxes, or part of them, should be set apart 
for use as a safety fund to be applied in making 
good any losses through default of banks in keeping 
up their note-redemption funds. 



Existing Bond-Secured Notes 

The uncovered amount of bank-notes now out- 
standing in the United States is larger in proportion 
to the total currency of the country, and in pro- 
portion to population, than is the uncovered 
amount of bank-notes outstanding in England, 
France, or Germany. Experience has shown that 
the volume of bank-notes outstanding in the United 
States is too large, except when an extraordinary 
amount of currency is needed for circulation, or 
when there is a bank panic. In order to place 
financial conditions in the United States upon a 
sound basis, it is necessary that any increase of the 
present inelastic volume of bank-notes be stopped. 
No plan can be sound that provides merely for the 
issue of more bank-notes on top of the present 
bond-secured notes. No plan can be sound unless 
it shall provide for elasticity in the uncovered volume 

117 



THE BANKING AND CURRENCY PROBLEM 

of bank-notes, so that an excessive amount of the 
notes shall not remain outstanding in normal times. 
After some years, owing to the growth of the 
country in population and in wealth, the present 
volume of bank-notes probably would cease to be 
excessive even in normal times, but it is very de- 
sirable that at least a portion of the bond-secured 
notes be replaced, as soon as possible, by an issue of 
notes that can be contracted in normal times by 
some central authority. It is proposed to bring 
about this result as follows : 

(a) No United States bonds hereafter issued shall 
be receivable as security for bond-secured notes 
under existing laws. 

(b) No bank being a member of the proposed as- 
sociation shall be permitted to issue bond-secured 
notes under the existing laws to an amount ex- 
ceeding 50 per cent, of its capital stock. If any 
such bank at the time of becoming a member of the 
association shall have outstanding notes issued un- 
der existing laws to an amount exceeding 50 per 
cent, of its capital stock, such bank shall not be 
allowed to issue notes under existing laws upon re- 
demption of any of such outstanding notes until the 
amount of these notes issued pursuant to existing 
laws shall be reduced below 50 per cent, of the 
capital stock of the bank. 

(c) After the satisfactory operation of the plan 

118 



IN THE UNITED STATES 

shall have been established, further restrictions 
should be imposed upon the issue of bond-secured 
notes under the existing laws, so as to force the 
gradual substitution of notes issued under the pro- 
posed plan for the present bond-secured notes. 

The banks would be protected against loss re- 
sulting from a forced reduction of their issues of 
bond-secured notes, because they would acquire the 
right to issue notes under the new plan and could 
use their United States bonds as collateral for the 
uncovered part of these notes, thereby saving the 
higher taxes which would be payable by those 
banks that do not deposit United States bonds. 



THE END 



JAN 311 IS 



